RBI Notifications

RBI Notifications

Why has RBI policy panel kept repo rate unchanged, hiked GDP growth projection?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Monetary Policy Committee (MPC)

Mains level: Why Did the RBI Keep the Rates Unchanged?

Why in the news?

The RBI’s Monetary Policy Committee kept the repo rate at 6.5% for the eighth consecutive time, due to persistent high retail inflation from sticky food prices.

Monetary Policy Committee (MPC) 

  • The Monetary Policy Committee (MPC) of India is responsible for setting the benchmark interest rate in the country.
  • The committee consists of six members: the Governor of the Reserve Bank of India (RBI), the Deputy Governor in charge of monetary policy, an Executive Director of the RBI, and three external members nominated by the government.
  • The MPC meets at least four times a year and publishes its decisions after each meeting. The committee’s primary objective is to maintain price stability while considering the goal of economic growth.

Why did the RBI keep the Rates Unchanged?

  • Inflation Concerns: The Monetary Policy Committee (MPC) kept the repo rate unchanged at 6.5% due to persistent high inflation, with April 2024 retail inflation at 4.83%.
  • Caution on Food Inflation: The policy stance remains cautious due to the risk of rising food inflation from heatwave conditions, which may impact the final journey of disinflation.
  • Flexible Inflation Targeting: Under the regime, the RBI aims to keep inflation within the 2-6% range and achieve a 4% target on a durable basis.
  • Supply Side Disruptions: Persistent supply shocks in cereals, pulses, spices, and vegetables contributed to elevated food inflation, impacting overall inflation management.

What happens to Lending Rates if the Repo Rate is left steady?

Lending Rate:

The lending rate, also known as the bank rate, is the rate at which commercial banks borrow money from the central bank without securities. It is typically higher than the repo rate and is used for longer-term lending. The lending rate is used to assess the long-term monetary goals of a bank and is often used to manage liquidity in the system

Repo Rate 

The repo rate, on the other hand, is the rate at which the central bank lends money to commercial banks against government securities as collateral. It is used for short-term lending and is typically lower than the lending rate

  • Relief for Borrowers: With the repo rate steady at 6.5%, external benchmark lending rates (EBLR) linked to the repo rate will not increase, keeping equated monthly installments (EMIs) on home and personal loans unchanged.
  • Potential MCLR Increase: Lenders might raise interest rates on loans linked to the marginal cost of fund-based lending rate (MCLR), as the full transmission of the 250 basis points hike in the repo rate from May 2022 to February 2023 has not yet occurred.

Why Has MPC Hiked GDP Growth?

  • Improving Demand: The MPC raised the GDP growth forecast for FY25 to 7.2% from 7% due to strengthening rural and urban demand conditions buoyed by favourable monsoon forecasts.
  • Robust Economic Activity: Indicators such as healthy growth in the eight core industries, strong Purchasing Managers Index (PMI) in manufacturing and services, and overall resilient domestic economic activity support the upgraded growth projection.
  • Sectoral Strength: The manufacturing and services sectors continued to exhibit robust performance, with the PMI for services standing at 60.2 in May 2024, indicating strong expansion.

Conclusion: The RBI’s cautious approach to keeping rates steady while boosting GDP growth projections aims to balance economic growth and inflation control, with a focus on addressing persistent food inflation.

Mains PYQ:

Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC IAS/2019)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI brings back 100 tonnes Gold from UK to its Vaults 

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Gold Reserves of RBI

Why in the News?

The RBI has repatriated over 100 tonnes of gold from the UK to its domestic vaults, the largest transfer since at least 1991.

What are Gold Reserves?

    • A gold reserve is the gold held by a country’s central bank, acting as a backup for financial promises and a store of value.
    • India, like other nations, stores some of its gold reserves in foreign vaults to spread out risk and facilitate international trading.
  • India’s Gold Reserves:
    • As of the end of March 2024, the RBI held 822.10 tonnes of gold, with 408.31 tonnes stored domestically.
    • The share of gold in the total forex of India is around 7-8% as of 2023.

Where does the RBI store its gold?

  • India’s gold reserves are primarily stored in the Bank of England, which is known for its stringent security protocols.
  • The RBI also stores a portion of its gold reserves at the:
  1. Bank for International Settlements (BIS) in Basel, Switzerland, and the
  2. Federal Reserve Bank of New York in the United States.
  • During India’s foreign exchange crisis in 1990-91, the country pledged some of its gold reserves to the Bank of England to secure a $405 million loan, according to reports.
  • Even though the loan was paid back by November 1991, India decided to keep the gold in the UK for convenience.

Why does the RBI store its gold in foreign banks?

  • Convenience: Storing gold overseas makes it easier for India to trade, engage in swaps and earn returns.
  • Averting Risks: There are risks involved, especially during times of geopolitical tensions and war.
    • The recent freezing of Russian assets by Western nations has raised worries about the safety of assets kept abroad and the RBI decision to shift a portion of the gold reserve to India could be prompted by these concerns.
  • Stable Prices: Unlike fiat currencies, which can be subject to inflation or devaluation due to various economic factors, the value of gold tends to be relatively stable over time, which makes it an attractive asset for central banks to hold as a reserve.

Benefits Offered by Gold Reserves

  • Control domestic gold prices: With its big stash of gold, the RBI can help control local gold prices by using some of it in India. Last financial year, the RBI added about 27.47 tonnes of gold to the total reserve, bringing it to 794.63 tonnes.
  • Security buffer: The increased gold reserve works as a hedge against any financial crisis and to take measures to control inflation as well as currency devaluation.

Why is the recent move significant?

  • Efficiency and Confidence: Bringing gold back to India reduces storage fees and signals confidence in the stability of the Indian economy.
  • Logistical Efficiency: Moving gold to India saves on storage fees paid to foreign custodians, such as the Bank of England.
  • Diversified Storage: Repatriation ensures diversified storage, enhancing security and reducing dependency on foreign storage.

Has the RBI made similar purchases or transfers of gold in the past?

  • RBI started buying gold in 2018 and had previously bought 200 tonnes during the global financial crisis in 2009.
  • In the first quarter of 2024, the RBI bought 19 tonnes of gold, surpassing the 16 tonnes purchased throughout 2023.

PYQ:

[2015] The problem of international liquidity is related to the non-availability of:

(a) Goods and services

(b) Gold and silver

(c) Dollars and other hard currencies

(d) Exportable surplus

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Surge in Indian Companies’ External Commercial Borrowings (ECBs)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: External Commercial Borrowings (ECBs)

Why in the News?

Indian companies “external commercial borrowings” nearly doubled in FY24, reaching $49.2 billion, according to RBI data.

Key Statistics:

  • Disbursements: ECB disbursements stood at $38.4 billion in FY24, a significant increase from $23.8 billion in FY23, underscoring the growing reliance on overseas markets for funding.
  • Domestic Pressure: High interest rates in the domestic system have led to increased pressure, prompting companies to explore ECBs as a viable funding alternative.

External Commercial Borrowing (ECBs) in India:

Details
Definition Loans provided by non-resident lenders in foreign currency to Indian borrowers.
Usage Widely used by Indian corporations and PSUs to access foreign funds.
Instruments Covered Commercial bank loans, buyers’ credit, suppliers’ credit, securitised instruments (floating rate notes, fixed-rate bonds), credit from official export credit agencies, and commercial borrowings from multilateral financial institutions.
Regulation Monitored and regulated by the Department of Economic Affairs (DEA) under the Ministry of Finance, Government of India, along with the Reserve Bank of India.
Contribution Contributed between 20 and 35% of total capital flows into India in 2012.
Recent Changes RBI raised ECB limit for infrastructure finance companies from 50% to 75% of owned funds.
Guideline Changes RBI allowed all eligible borrowers to raise ECB up to USD 750 million per financial year under the automatic route (2019).
Utilisation of Funds 25% of ECB can be used to repay rupee debt; 75% should be allocated for new projects.
Regulatory Framework Governed by the Foreign Exchange Management Act, 1999.
Routes for Raising ECBs Automatic Route and Approval Route.

  1. Automatic Route: Cases examined by AD (Authorized Dealer) Category-I Banks.
  2. Approval Route: Borrowers submit requests to RBI through their AD banks for examination.
Maturity Period ECBs can only be raised for a specific period known as the Minimum Average Maturity Period (MAMP).
Advantages Offered
  • ECBs offer the opportunity to secure substantial funding.
  • These funds typically come with longer-term repayment options.
  • Interest rates on ECBs are generally lower compared to domestic borrowing rates.
  • ECBs are denominated in foreign currencies, providing corporations with access to foreign currency to fulfil import needs such as machinery procurement.

 

PYQ:

[2019] Consider the following statements :

  1. Most of India’s external debt is owed by governmental entities.
  2. All of India’s external debt is denominated in US dollars.

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI launches PRAVAAH, Retail Direct mobile app and FinTech Repository

Note4Students

From UPSC perspective, the following things are important :

Prelims level: PRAVAAH, Retail Direct Mobile App, G-Secs, EmTech Repository

Why in the News?

  • The Reserve Bank of India (RBI) recently introduced three significant initiatives: the PRAVAAH portal, the RBI Retail Direct mobile application, and the FinTech Repository.
    • These initiatives aim to streamline regulatory processes, empower retail investors, and provide insights into the fintech sector.

1. PRAVAAH Portal:

  • The PRAVAAH portal (Platform for Regulatory Application, VAlidation, and AutHorisation) serves as a centralised web-based platform for individuals and entities to seek regulatory approvals from the RBI.
  • Offering features like online application submission and status tracking, the portal covers 60 different application forms across various regulatory departments, ensuring efficiency and transparency in the authorisation process.

2. RBI Retail Direct Mobile App:

  • The RBI Retail Direct Mobile App provides retail investors with convenient access to government securities (G-Secs) trading directly from their smartphones.
  • Accessible on both Android and iOS platforms, the app simplifies transactions in both primary and secondary markets, empowering retail investors to participate more actively in the securities market.

3. FinTech Repository:

The FinTech Repository aims to provide comprehensive data on Indian fintech firms, facilitating better regulatory understanding and policy formulation in the rapidly evolving fintech landscape.

Other initiatives launched:

  • EmTech Repository: It focuses on RBI-regulated entities’ adoption of emerging technologies like AI, ML, Cloud Computing, and Quantum, providing valuable insights for policymakers and industry stakeholders.
  • Reserve Bank Innovation Hub (RBIH): Both repositories are managed by the RBIH, underscoring the central bank’s commitment to fostering innovation and collaboration in the financial sector.

 

PYQ:

[2013] In the context of the Indian economy, ‘Open Market Operations’ refers to:

(a) borrowing by scheduled banks from the RBI

(b) lending by commercial banks to industry and trade

(c) purchase and sale of government securities by the RBI

(d) None of the above

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s Proposed Framework to Administer Project Financing | Explained

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Functions of RBI; Date of Commencement of Commercial Operations;

Mains level: Banking and Regulations; Issue of NPA’s;

Why in the News?

The RBI has issued draft regulations for a Harmonized Prudential Framework and revised DCCO criteria, to enhance the Regulatory Framework for long-term (infrastructure, non-infrastructure, and commercial real estate sectors) project financing.

  • RBI’s purpose behind this is to regulate and supervise payment and settlement systems in the country, ensuring safe, secure, and efficient mechanisms for financial transactions.

What is the Date of Commencement of Commercial Operations (DCCO)?

The DCCO is a critical milestone for project loans, indicating the start of revenue-generating activities for the project.

Banks maintain the DCCO for project loans for several key reasons:

  • Asset classification: The DCCO is crucial for determining the asset classification of a project loan. If the project fails to commence commercial operations by the stipulated DCCO, the loan may be classified as a Non-performing asset (NPA).
  • Restructuring: The DCCO is used as a reference point for allowing the restructuring of project loans without treating it as an NPA. RBI guidelines permit banks to extend the DCCO by up to 1 year for commercial real estate projects and up to 2 years for infrastructure projects, without downgrading the asset classification, provided certain conditions are met.
  • Viability assessment: When extending the DCCO, banks must satisfy themselves about the viability of the project and the restructuring plan.
  • Provisioning: If a loan remains in the pre-commencement of the commercial operations phase for an extended period, banks may need to make higher provisions, considering the risk involved.
  • Monitoring and control: Maintaining a clear DCCO allows banks to monitor the project’s progress and take timely action if there are delays or cost overruns. This helps in managing the bank’s exposure and mitigating risks.

Key Highlights of the Proposed New Framework:

  • Income Recognition and Asset Classification: The draft framework outlines guidelines for Income Recognition, Asset Classification, and Provisioning of Advances for Projects Under Implementation (IRACP-PUIMP).
    • It emphasizes the importance of monitoring stress in projects and initiating resolution plans proactively.
    • Increase in general provisioning at the construction stage from 0.4% to 5% on all existing and fresh exposures, phased over three years (2% for FY25, 3.5% for FY26, and 5% for FY27).
  • Restructuring Norms: The RBI has prescribed norms for restructuring exposure in projects due to changes in the DCCO.
    • Lenders are required to have a board-approved policy for resolving stress in projects, triggered by a credit event during the construction phase.
    • Provisioning can be reduced to 2.5% and 1% at the operational phase if certain conditions are met.
  • Consortium Arrangements: In projects financed under consortium arrangements, specific exposure limits have been set based on the aggregate exposure of lenders.
    • Individual lenders must maintain a Minimum Exposure Percentage to ensure a balanced risk-sharing mechanism.
  • Financial Closure and Repayment Structure: The framework mandates that financial closure must be achieved before the disbursement of funds.
    • It discourages moratoriums on repayments beyond the DCCO period and sets guidelines for the repayment tenor not exceeding 85% of the economic life of the project.
    • Projects must demonstrate a positive net operating cash flow to cover all repayment obligations and a reduction in total long-term debt by at least 20%.
  • Net Present Value (NPV) Requirement: A positive NPV is a prerequisite for any project financed by lenders. The RBI stresses the importance of reevaluating the project NPV annually to ensure financial viability and address credit impairment risks.
    • Guidelines for a standby credit facility to fund cost overruns due to delays, with incremental funding of 10% of the original project cost.

ICRA Observations:

ICRA set up in 1991 is an independent and professional investment Information and Credit Rating Agency. It observed the proposed new framework could have the following implications:

  • Profitability Impact: Higher provisioning requirements for projects under implementation could impact the profitability of Non-banking Financial Companies and Infrastructure Financing Companies. The impact will be spread over 3 years.
  • Funding Costs: Estimated increase in funding costs by 20-40 basis points as lenders build additional risk premiums.
    • Major banks like SBI, Union Bank of India, and Bank of Baroda do not foresee significant impacts, although the pricing of loans may need adjustments.

Way Forward:

  • Enhanced Monitoring and Compliance: Implement robust monitoring mechanisms to ensure compliance with the new regulations. Regularly review and update the prudential framework to adapt to evolving market conditions.
  • Capacity Building: Train bank staff and stakeholders on the new regulatory requirements and best practices for project financing.

Prelims PYQ: 

Q The Reserve Bank of India regulates the commercial banks in matters of:  (UPSC CSE 2013)

  1. liquidity of assets
  2. branch expansion
  3. merger of banks
  4. winding-up of banks

Select the correct answer using the codes given below.

(a) 1 and 4 only

(b) 2, 3 and 4 only

(c) 1, 2 and 3 only

(d) 1, 2, 3 and 4

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

CBDC pilot programmes for CPs, CDs likely: RBI

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CBDC, CPs, CDs;

Mains level: NA

Why in the news?

RBI Governor Shaktikanta Das unveiled plans for a pilot program targeting the wholesale segment of Central Bank Digital Currency (CBDC) focusing on commercial papers (CPs) and certificates of deposits (CDs).

What is Central Bank Digital Currency (CBDC)?

  • CBDC is a legal tender to be issued by the central bank in digital form; like rupee notes or coins, which are in physical form.
  • It was announced in the Union Budget 2022-23.
  • Subsequently, the Government amended Section 22 of the RBI Act, 1934 through the Finance Bill 2022. [Ref].
  • Working of CBDC:
    • Like fiat currency, it can also be exchanged between people. Simply, put it’s just like rupee (₹) notes but in digital form (e₹). 
    • However, unlike fiat currency that’s usually stored in banks and hence their liability, CBDC is a liability on the RBI’s balance sheet.
    • That’s why one does not necessarily need to have a bank account to own a digital rupee.

 

About Commercial Papers (CPs) and Certificates of Deposits (CDs)

Commercial Papers Certificates of Deposits
Type of Instrument Unsecured promissory note Fixed-income financial instrument
Issuer Large corporations, primary dealers, financial institutions Scheduled Commercial Banks, All-India Financial Institutions
Maturity Period 1 to 364 days 3 months to 1 year (for SCBs), 1 to 3 years (for financial institutions)
Minimum Investment Rs. 5 lakh or multiples thereof Rs. 1 lakh or multiples thereof
Credit Rating Requirement Minimum credit rating required (e.g., A-2) from recognized rating agencies Typically issued by highly rated banks and financial institutions
Collateral Unsecured Not applicable
Purpose Short-term funding for corporations Short to mid-term investment for individuals and institutions
Interest Rate Typically higher than bonds, fluctuates with market conditions Typically fixed, higher than savings accounts, fluctuates with market conditions
Investment Eligibility Individuals, banking companies, corporate bodies (registered or incorporated in India), NRIs, FIIs, etc. Individuals, banking companies, other corporate bodies, NRIs, FIIs, etc.
Issuing and Paying Agent (IPA) Only scheduled banks act as Issuing and Paying Agent Not applicable
Trading Actively traded in Over-the-Counter (OTC) market, reported on Fixed Income Money Market and Derivatives Association of India (FIMMDA) reporting platform Not publicly traded
Dematerialized Holding Can be held in dematerialized form through Securities and Exchange Board of India (SEBI)-approved depositories Can be issued in dematerialized form through SEBI-approved depositories

 

With inputs from: https://www.indiainfoline.com

PYQ:

[2020] With reference to the Indian economy, consider the following statements:

  1. ‘Commercial Paper’ is a short-term unsecured promissory note.
  2. ‘Certificate of Deposit’ is a long-term instrument issued by the Reserve Bank of India to a corporation.
  3. ‘Call Money’ is a short-term finance used for interbank transaction.
  4. ‘Zero-Coupon Bonds’ are the interest-bearing short-term bonds issued by the Scheduled Commercial Banks to corporations.

Which of the pairs above is/are correctly matched?

(a) 1 and 2 only

(b) 4 only

(c) 1 and 3 only

(d) 2, 3 and 4 only

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s New Guidelines for Asset Reconstruction Companies (ARCs)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Asset Reconstruction Companies, SARFAESI Act, 2002;

Mains level: NA

Why in the news?

The RBI has introduced updated guidelines for Asset Reconstruction Companies (ARCs) through a master direction, effective from April 24, 2024.

What is an Asset Reconstruction Company (ARC)?

Description
About ARC is a special financial institution that acquires debtors from banks at a mutually agreed value and attempts to recover the debts or associated securities.
Regulation
  • ARCs are registered under the RBI.
  • Regulated under the SARFAESI Act, 2002 (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act).
Objective ARCs take over a portion of the bank’s non-performing assets (NPAs) and engage in asset reconstruction or securitization, aiming to recover the debts.
Functions
  • Asset Reconstruction: Acquisition of bank loans or other credit facilities for realization.
  • Securitization: Acquisition of financial assets by issuing security receipts.
Foreign Investment 100% FDI allowed in ARCs under the automatic route.
Limitiations
  • ARCs are prohibited from undertaking lending activities.
  • They can only engage in securitization and reconstruction activities.
Working
  • Bank with NPA agrees to sell it to ARC at a mutually agreed value.
  • ARC transfers assets to trusts under SARFAESI Act.
  • Upfront payment made to bank, rest through Security Receipts.
  • Recovery proceeds shared between ARC and bank.
Security Receipts Issued to Qualified Institutional Buyers (QIBs) for raising funds to acquire financial assets.
Significance
  • Banks can clean up their balance sheets and focus on core banking activities.
  • Provides a mechanism for resolution of NPAs and debt recovery.

What are the new guidelines laid out by the RBI?

  • Enhanced Capital Requirements:
      • Minimum Capital Requirement Increase: ARCs are now mandated to maintain a minimum capital requirement of Rs 300 crore, a significant increase from the previous Rs 100 crore stipulation established on October 11, 2022.
      • Transition Period for Compliance: Existing ARCs are granted a transition period to reach the revised Net Owned Fund (NOF) threshold of Rs 300 crore by March 31, 2026.
      • Interim Requirement: However, by March 31, 2024, ARCs must possess a minimum capital of Rs 200 crore to comply with the new directives.
  • Supervisory Actions for Non-Compliance:
      • ARCs failing to meet the prescribed capital thresholds will face supervisory action, potentially including restrictions on undertaking additional business until compliance is achieved.
  • Expanded Role for Well-Capitalized ARCs:
    • Empowerment of Well-Capitalized ARCs: ARCs with a minimum NOF of Rs 1000 crore are empowered to act as resolution applicants in distressed asset scenarios.
    • Investment Opportunities: These ARCs are permitted to deploy funds in government securities, scheduled commercial bank deposits, and institutions like SIDBI and NABARD, subject to RBI specifications. Additionally, they can invest in short-term instruments such as money market mutual funds, certificates of deposit, and corporate bonds commercial papers.
    • Investment Cap: Investments in short-term instruments are capped at 10% of the NOF to mitigate risk exposure.

PYQ:

[2018] With reference to the governance of public sector banking in India, consider the following statements:

  1. Capital infusion into public sector banks by the Government of India has steadily increased in the last decade.
  2. To put the public sector banks in order, the merger of associate banks with the parent State Bank of India has been affected.

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Towards a Green Growth: On the RBI and a Green Taxonomy

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Monetary Policy

Mains level: The impact of climate shock and extreme weather events

Why in the news?

Extreme weather conditions may pose a risk to inflation, along with prolonged geopolitical tensions that could keep crude oil prices volatile, the Reserve Bank’s April Bulletin said on April 23.

RBI’s Monetary Policy Report on the impact of climate shock and extreme weather events on food inflation:

  • Effects of Food Inflation: The report highlights the significance of extreme weather events and climate shocks in affecting not only food inflation but also the broader impact on the natural Rate of Interest and Financial Stability.
  • Broader Economic Impact: Climate shocks and extreme weather events are mentioned to have a broader impact on the economy’s financial stability, indicating that disruptions in food production and supply chains due to these events can lead to inflationary pressures beyond just the food sector.
  • Use of Economic Modeling: The report mentions the utilization of a New-Keynesian model incorporating a physical climate risk damage function to estimate the macroeconomic impact of climate change. This likely includes projections on how climate shocks affect food production and subsequently food inflation.
  • Warning on Long-Term Output Reduction: The report warns that without climate mitigation policies, the long-term economic output could be lower by around 9% by 2050. This suggests that climate shocks and extreme weather events could have lasting effects on food production and inflation.
  • Potential for Inflation Hysteresis: There’s a warning about the potential for inflation hysteresis to become entrenched, which could lead to a de-anchoring of inflation expectations. This implies that persistent disruptions caused by climate shocks could lead to sustained increases in food inflation.

Way Forward:

  • Need Investment in Climate Resilience: Governments and businesses can invest in climate-resilient agriculture practices and infrastructure to mitigate the adverse effects of extreme weather events on food production.
  • Need Diversification of Food Sources: Diversifying food sources can help reduce reliance on regions prone to climate-related disruptions. This could involve promoting local food production, supporting small-scale farmers, and investing in alternative food production methods such as vertical farming or hydroponics.

Mains PYQ 

Q What policy instruments were deployed to contain the great economic depression?

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s latest recommendations to regulate payment aggregators in offline spaces | Explained

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Payment aggregators

Mains level: What exactly are the norms about?

Why in the news?

The Reserve Bank of India (RBI) has floated two consultation papers seeking enhanced regulation of payment aggregators carrying out face-to-face transactions. It also seeks to strengthen the ecosystem’s safety.

What is Payment Aggregators?

  • A payment aggregator is a payment solution or a platform provider that aggregates various payment modes such cards, UPI, net-banking, wallets and alternate credit products by partnering with various processing entities such as acquiring banks, direct banks (in case of net banking) and issuers of wallets and alt credit products on to a single platform.

What exactly are the norms about?  

  • Extension to Offline Transactions: The existing guidelines for payment aggregators cover their activities in e-commerce and online platforms. The latest draft proposes extending these regulations to offline spaces, including proximity or face-to-face transactions.
  • Convergence on Standards: The proposed norms aim to achieve convergence on standards of data collection and storage across online and offline transactions handled by payment aggregators.
  • Elaborate Guidelines: The proposed norms are detailed and comprehensive, reflecting lessons learned from incidents such as the Paytm Payments Bank crisis.
  • Strengthening Ecosystem: RBI’s objective seems to be strengthening the payment aggregator ecosystem against opacity and ensuring compliance with regulatory standards.
  • Penalties for Non-Compliance: The Financial Intelligence Unit (FIU-IND) imposed penalties on Paytm Payments Bank for engaging in illegal activities and failing to adhere to regulatory requirements, indicating strict consequences for non-compliance with the proposed norms.

Is registration with the RBI being made compulsory?  

The primary focus of this guidlines is on non-bank PAs and within them, the offline extensions.

  • PA based on Bank: Banks providing physical PA services as part of their normal banking relationship would not require any separate authorisation from the RBI. They are only expected to comply with the revised instructions within three months after they are issued.
  • PA without Banking: Non-banking entities providing PA services at the point of sale (PoS), that is, offline, would have to inform RBI within 60 days (after the circular is issued), about their intent to seek authorisation.

Does it talk about provisions for sustainability?  

  • Minimum net worth aims to ensure the sustainability of non-banking entities: While the proposed norms primarily focus on regulatory compliance and financial stability, the requirement for a minimum net worth aims to ensure the sustainability of non-banking entities providing proximity/face-to-face transaction services. This is because entities with a stronger financial base are better positioned to weather economic challenges and uncertainties, thus promoting sustainability in the long run.
  • Risk-Based Payments: Payment aggregators are required to assign risk-based payments to merchants, focusing on sustainability. This involves assessing the risk associated with each merchant and adjusting payment terms accordingly.

What about KYC requirements?  

  • Extended Scope of KYC: The proposed regulations aim to extend the scope of Know Your Customer (KYC) requirements for merchants onboarded by payment aggregators. While KYC is already mandatory, the regulations seek to make the provisions more nuanced.
  • Document Verification for Medium Merchants: Medium merchants, with a higher annual turnover threshold, must undergo additional document verification. Payment aggregators are expected to verify one official document each of the proprietor, beneficial owner or attorney holder, and the stated business.
  • Ongoing Compliance Monitoring: Payment aggregators must ensure that transactions undertaken by their merchants are in line with their business profiles. This involves ongoing monitoring to ensure compliance with KYC requirements and business activities.

Conclusion: 

The proposed norms aim to achieve convergence on standards of data collection and storage across both online and offline transactions handled by payment aggregators. This helps in streamlining regulatory requirements and ensuring consistency in data management practices.

Mains PYQ 

How can the Digital India program help farmers to improve farm productivity and income? What step has the government taken in this regard? (UPSC IAS/2015)

With Inputs from:

https://www.thehindu.com/business/rbi-clampdown-on-lenders-could-moderate-credit-growth-in-2024-25/article67994838.ece

https://www.thehindu.com/business/Industry/rbi-to-introduce-offline-erupee-transactions-soon-shaktikanta-das/article67824286.ece

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Special Rupee Vostro Account (SRVA)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Nostro, Vostro and Loro Accounts,SRVA

Mains level: Trade Settlement Mechanisms in Rupee

Why in the news?

India has simplified the payment mechanism for traders importing pulses from Myanmar, requiring them to use the Rupee/Kyat direct payment system through the Special Rupee Vostro Account (SRVA) through the Punjab National Bank.

International Transactions Settlement Mechanism:

[1] Vostro Accounts:

  • Named from the Latin word “vostro,” meaning “yours.”
  • Represents a domestic bank’s account held by a foreign bank in the local currency (e.g., INR in India).
  • Allows foreign banks to manage local currency transactions on behalf of their clients.
  • For example, a foreign bank holding an account in an Indian bank in Indian Rupees (INR) for facilitating transactions within India.

[2] Nostro Accounts:

  • Derived from the Latin word “nostro,” meaning “ours.”
  • Refers to a foreign bank’s account held by a domestic bank in the foreign currency (e.g., USD in the United States).
  • Enables domestic banks to handle foreign currency transactions for their clients.
  • For instance, an Indian bank holding an account in a U.S. bank in U.S. Dollars (USD) to facilitate international transactions in the U.S. currency.

[3] Loro Accounts:

  • From the Italian word “loro,” meaning “their.”
  • Represents an account held by one foreign bank in another foreign bank’s currency.
  • Facilitates interbank transactions between two foreign banks without converting currencies into a domestic currency.
  • For example, if a bank in India holds an account in a bank in the United States in USD (U.S. Dollars) to facilitate transactions between those two banks.

What is Special Rupee Vostro Account (SRVA)?

Information
Definition Domestic banks hold INR accounts for foreign banks, promoting direct trade in rupees.
Purpose
  • Complements existing currency systems, allowing INR-based settlements.
  • Reduces reliance on foreign currencies, mitigating economic shocks.
  • Aims to elevate INR’s global status and facilitates trade with sanctioned countries.
Framework Components
  • All exports and imports invoiced in INR.
  • Exchange Rate is Market-determined.
  • Final trade settlements takes place in INR.
Functioning
  • Indian banks open SRVA accounts for foreign banks.
  • INR used for import payments and export receipts.
Compliance
  • Enables advance payments for Indian exporters, complying with Foreign Exchange Management Act (FEMA), 1999.
  • Correspondent bank should not from a country mentioned in the updated Financial Action Task Force (FATF) Public Statement on High Risk & Non-Co-operative jurisdictions
Purpose of the Arrangement
  • Reduces demand for foreign currencies, increasing INR use in trade.
  • Mitigates economic shocks by minimizing reliance on foreign exchange.
  • Aims to boost INR’s global acceptance and facilitates trade with sanctioned nations.

 

How are the SRVA different from the already existing Rupee Vostro Account?

  • The settlement of International trade through Indian Rupees (INR) is an additional arrangement to the existing system of settlement.
  • SRVA requires prior approval (of RBI) before opening unlike Rupee Vostro account.

PYQ:

[2015] Convertibility of rupee implies:

(a) being able to convert rupee notes into gold

(b) allowing the value of rupee to be fixed by market forces

(c) freely permitting the conversion of rupee to other currencies and vice versa

(d) developing an international market for currencies in India

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Why RBI has been wary of declaring an early victory over inflation?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Banking; RBI; The Monetary Policy Committee (MPC);

Mains level: Banking; RBI; Functions of the RBI;

Why in the news? 

Recently, the Monetary Policy Committee (MPC), which met here from April 3 to 5, decided to keep the repo rate unchanged at 6.5% and maintain the policy stance of ‘withdrawal of accommodation’ in the monetary policy.

  • Withdrawal of accommodation means reducing the money supply in the system which will rein in inflation further. (Temporary Provision)

Why the RBI has been wary of declaring an early victory over inflation?

  • Persistent Food Inflation: Despite expectations of moderation in inflation, food inflation has remained a concern, especially due to the high prices of food grains and vegetables. In February, food inflation was at 8.7%, with foodgrain inflation still high at 9.8%.
  • Inflation Gap between Bottom and Top of Urban Population: Food inflation disproportionately affects lower-income deciles more than higher ones. In February, the bottom 20% of the urban population faced 5.5% inflation compared to 4.7% for the top 20%. This pattern is similar in rural areas as well.
  • Management Issues: The RBI faces challenges in managing inflation while maintaining growth, especially when inflation persists due to Geopolitical conditions. While central bank policy moves cannot directly bring down supply shock-driven inflation, they can prevent high prices from spilling over.

 Why RBI has kept policy rates unchanged?

  • High Economic Growth: The RBI is focused on maintaining price and financial stability to sustain high growth. The central bank expects the Indian economy to grow at 7% in fiscal year 2024-25
  • Benign Core Inflation: Benign core inflation, which has declined steadily over the past months, indicates that strong growth has not been inflationary. The RBI finds comfort in the declining core inflation levels
  • Monetary Policy Stance associated with food inflation: The RBI is likely to maintain policy rates until October 2024 to assess evolving risks associated with food inflation. The central bank is cautious and prefers to adopt a risk-minimization mode to align inflation towards the target while supporting growth
  • Global Economic Conditions: The RBI is monitoring global economic trends and external factors that could impact domestic inflation and growth. The central bank is aware of the risks posed by geopolitical tensions, volatility in international financial markets, and geo-economic fragmentation

 

BACK2BASICS

The Monetary Policy Committee (MPC)

  • It is a key body responsible for formulating the country’s monetary policy. It  is a statutory body constituted as per Section 45ZB under the RBI Act of 1934 by the Central Government
  •  It is a six-member committee established under the amended Reserve Bank of India Act, of 1934. The MPC’s primary objective is to determine the policy rate required to achieve the inflation target set by the government. The committee consists of the following members:
    • RBI Governor (ex officio chairperson)
    • Deputy Governor in charge of monetary policy
    • An officer of the Bank nominated by the Central Board
    • Three members appointed by the central government
  • The MPC meets at least four times a year, and decisions taken by the committee are binding on the Reserve Bank of India.
  • The committee’s composition ensures a mix of expertise in economics, banking, finance, and monetary policy to effectively manage the country’s Monetary Policy Framework.

 

Conclusion: The RBI has been cautious due to persistent food inflation impacting lower income groups, challenges in managing it, and the need to assess evolving risks. MPC’s unchanged policy rates reflect this caution amidst high growth and benign core inflation.

Mains pyq 

Q Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC IAS/2019)

Source https://indianexpress.com/article/opinion/columns/why-rbi-wary-of-declaring-early-victory-over-inflation-9253330/

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to launch Mobile App for Retail Direct scheme

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Retail Direct Scheme

Mains level: NA

Why in the news?

The RBI has decided to introduce a Mobile App of its RBI Retail Direct scheme aimed at facilitating seamless investment in government securities by retail investors.

What is Retail Direct Scheme?

  • Retail Direct Scheme was rolled out in November 2021, giving access to individual investors to maintain gilt accounts with RBI and invest in government securities.
  • Using this app, investors can buy central and state government bonds as well as Treasury bills.
  • It enables investors to buy securities in primary auctions as well as buy/sell securities through the Negotiated Dealing System-Order Matching system (NDS-OM) platform.
  • A Gilt Account can be compared with a bank account, except that the account is debited or credited with treasury bills or government securities instead of money.

Treasury Bills:

  • They are promissory notes issued by the RBI on behalf of the government as a short term liability and sold to banks and to the public.
  • The maturity period ranges from 14 to 364 days.
  • They are the negotiable instruments, i.e. they are freely transferable.
  • No interest is paid on such bills but they are issued at a discount on their face value.

 How does it work?

  • Under the scheme, small investors can buy or sell government securities (G-Secs), or bonds, directly without an intermediary like a mutual fund.
  • However, the same tax rules apply to income from G-Secs.
  • The minimum amount for a bid is ₹10,000 and in multiples of ₹10,000 thereafter.
  • Payments may be made through Net banking or the UPI

Benefits of RDS

  • With the government being the borrower, there is a sovereign guarantee for the funds and hence zero risk of default.
  • Also, government securities may offer better interest rates than bank fixed deposits, depending on prevailing interest rate trends.

How can individuals access G-Sec offerings?

  • Investors wishing to open a Retail Direct Gilt account directly with the RBI can do so through an online portal set up for the purpose of the scheme.
  • Once the account is activated with the aid of a password sent to the user’s mobile phone, investors will be permitted to buy securities either in the primary market or in the secondary market.

PYQ:

[2018] Consider the following statements:

1. The Reserve Bank of India manages and services Government of India Securities but not any State Government Securities.

2. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.

3. Treasury bills offer are issued at a discount from the par value.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 only

(c) 2 and 3 only

(d) 1, 2 and 3

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Digital India Trust Agency (DIGITA) to check Illegal Lending Apps

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Digital India Trust Agency (DIGITA)

Mains level: NA

Why in the news?

To address the rising threat of cyber fraud, the Reserve Bank of India (RBI) is planning to establish a Digital India Trust Agency (DIGITA).

About Digital India Trust Agency (DIGITA)

DIGITA aims to tackle the proliferation of illegal lending apps by verifying and maintaining a register of authenticated digital lending platforms.

Role of DIGITA:

  1. Public Register: It will maintain a public register of verified apps, providing transparency and aiding law enforcement agencies in identifying unauthorised platforms.
  2. Verification Hub: It will serve as a central agency for vetting digital lending apps, ensuring their authenticity and compliance with regulations.

Regulatory Implications

  • Apps lacking the ‘verified’ signature from DIGITA will be deemed unauthorized, enhancing law enforcement efforts against financial crimes in the digital domain.
  • Verification processes will promote transparency and accountability within the digital lending sector, curbing fraudulent activities.

Progress made so far

  • The RBI has shared a list of 442 digital lending apps with the IT Ministry for whitelisting with Google.
  • Google has removed over 2,200 digital lending apps from its PlayStore, aligning with RBI and DFS directives to only allow apps from regulated entities or their partners.

PYQ:

2016:

Regarding ‘DigiLocker’, sometimes seen in the news, which of the following statements is/are correct?

1. It is a digital locker system offered by the Government under Digital India Programme.

2. It allows you to access your e-documents irrespective of your physical location.

Select the correct answer using the code given below.

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

 

Practice MCQ:

Consider the following statements about RBI led Digital India Trust Agency (DIGITA):

1.    It aims to tackle the proliferation of illegal lending apps.

2.    Apps lacking the ‘verified’ signature from DIGITA will be deemed unauthorized.

Which of the given statements is/are correct?

(a) Only 1

(b) Only 2

(c) Both 1 and 2

(d) Neither 1 nor 2

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Let’s make ₹ a global currency: PM to RBI

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Global Currency

Mains level: Indian Trades;

Why in the news? 

PM Modi asked the RBI to prepare a 10-year strategy to make the Indian rupee a globally “accessible and acceptable” currency and to meet the credit needs of every segment of the country

What is Global Currency?

A global currency refers to a single currency that is used by every country in the world. This concept involves all nations adopting the same currency for international trade and transactions

What are the major challenges for India to make Rupeea a Global Currency?

  • Economic Stability: The Indian economy would need to demonstrate consistent stability and growth to inspire confidence among international investors and users of the currency.  
  • Liquidity in Financial Market Development:  These markets need to be deep and liquid to accommodate large volumes of international transactions denominated in INR.
  • Capital Controls: India currently has restrictions on capital flows in and out of the country. These would need to be eased to facilitate international trade and investment denominated in INR.
  • Legal and Regulatory Framework: There would need to be robust legal and regulatory frameworks in place to govern the use of the INR in international transactions, including clearing and settlement systems, as well as dispute resolution mechanisms.
  • International/ Investors Acceptance: Convincing other countries, businesses, and individuals to adopt the INR as a global currency would require concerted diplomatic efforts, as well as initiatives to promote its use in international trade and finance.
  • Currency Convertibility: Full convertibility of the INR would be necessary for it to become a global currency.

Indian Efforts to Make Rupee a Global Currency:

  • RBI’s Roadmap for Rupee Internationalization: The RBI has published a report outlining a roadmap for the internationalization of the Rupee. This roadmap recommends actions such as including the Rupee in the Special Drawing Rights (SDR) basket, promoting its use in trade invoicing and settlement, facilitating its use in offshore markets, and developing financial products denominated in Rupees.
  • Promoting Use of Local Currencies for Cross-Border Transactions: India has been engaging in agreements with countries like the UAE to promote the use of local currencies, including the Rupee, for cross-border transactions.

Way Forward:

  • Need for Transactions in Rupee: To be an accepted International Currency, the Indian rupee is to be freely used in transactions by residents and non-residents and as a reserve currency for global trade.
  • Need to increase the Exports: Indian Trades need to be promoted beyond the Asian region.  All export and import transactions need to be invoiced in Indian rupees.
  • Reducing the Constraints: Legal and Regulatory frameworks need to be freed to attract investors for their business profits without hampering security concerns.

https://www.hindustantimes.com/india-news/lets-make-a-global-currency-pm-to-rbi-101711996093588.html

https://theprint.in/opinion/indian-rupee-can-become-global-reserve-currency-but-modi-govt-must-bring-reforms-for-that/1738000/

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

90 years of the Reserve Bank of India (RBI)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RBI, its regulatory functions, major achievements

Mains level: NA

Why in the news?

Recently, the RBI celebrated its 90th year in Mumbai, marking a significant milestone.

Dr. Ambedkar’s Role in the Establishment of RBI:

  • Dr. B.R. Ambedkar’s contributions were particularly notable during the Hilton Young Commission discussions in 1926, where he presented his recommendations based on his book “The Problem of the Rupee – Its Origin and Its Solution.”
  • These discussions laid the foundation for the establishment of the RBI on April 1, 1935.

About Reserve Bank of India (RBI)

  • The RBI is the central bank and monetary authority of India.
  • It was 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.
  • Sir Osborne Arkell Smith, an Australian, served as the inaugural Governor.
  • He was succeeded by Sir C D Deshmukh, the first Indian to hold the position.
  • 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.

Functions and Initiatives:

  • Monetary Authority: The RBI controls the supply of money in the economy to stabilize exchange rates, maintain a healthy balance of payment, and control inflation.
  • Issuer of Currency: Sole authority to issue currency and combat circulation of counterfeit notes.
  • Banker to the Government: Acts as a banker to both the Central and State governments, providing short-term credit and financial advisory services.
  • Lender of Last Resort: Provides emergency liquidity assistance to banks during crises.
  • Custodian of Foreign Exchange Reserves: Manages foreign exchange reserves and administers the Foreign Exchange Management Act, 1999 (FEMA).
  • Regulator and Supervisor of Payment and Settlement Systems: Oversees payment and settlement systems in the country, ensuring efficiency and security.
  • Credit Control and Developmental Role: Promotes credit availability to productive sectors and fosters financial infrastructure development.

Transformative Reforms initiated by the RBI

  • Green Revolution (1960s-1970s): Supported agricultural growth through credit facilities and rural credit accessibility enhancements.
  • Banks Nationalization (1969): Aimed at aligning banking sector objectives with national policy goals.
  • Priority Sector Lending (1972): Ensures timely credit flow to key sectors of the economy.
  • Economic Liberalization (1991): Opened up the economy to global markets, fostering market-oriented growth.
  • Unified Payment Interface (UPI), 2016: Enabled seamless and instant transactions across India.
  • Inflation Targeting Framework, 2016: Set inflation targets to guide monetary policy decisions.
  • Bharat Bill Payment System (BBPS), 2019: Launched an integrated bill payment system for customer convenience.
  • Aadhar-based eKYC (2019): Streamlined customer authentication processes for financial institutions.
  • Emergency Credit Line Guarantee Scheme (ECLGS), 2020: Provided credit assistance to SMEs affected by the COVID-19 pandemic.
  • Central Bank Digital Currency (2022): RBI is actively exploring the issuance of a CBDC known as e₹ (digital Rupee).
  • Cryptocurrency Regulation (2022): RBI has maintained a consistent stance against cryptocurrencies, advocating for an outright ban on them (after China and El Salvador imposed the complete ban). In 2020, the Supreme Court of India removed the ban on cryptocurrencies imposed by RBI.
  • Payment Vision 2025 Document (2023): The goals and vision of the RBI, are categorised in the Payments Vision 2025 documents into five anchor goalposts – Integrity, Inclusion, Innovation, Institutionalisation and Internationalisation.

 

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:

(a) 2 and 3 only

(b) 1 and 2 only

(c) 1 and 3 only

(d) 1, 2 and 3

 

2013: Consider the following statements: ​

1.    The Governor of the Reserve Bank of India (RBI) is appointed by the Central Government.​

2.    Certain provisions in the Constitution of India give the Central Government the right to issue directions to the RBI in public interest.​

3.    The Governor of the RBI draws his power from the RBI Act.​

Which of the above statements are correct?​

(a) 1 and 2 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

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

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Laws governing Loans/Lending in India

Mains level: NA

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

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI finalises Omnibus Framework for SROs in regulated entities

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Omnibus Framework

Mains level: Features of the Self-Regulatory Organization (SRO

Why in the news? 

  • The Reserve Bank of India (RBI) on Thursday said it had finalised the Omnibus Framework for recognising Self-Regulatory Organisations (SRO) for its Regulated Entities.

The key features of the Self-Regulatory Organization (SRO)- 

  • Omnibus Framework: The RBI has finalized an omnibus framework for recognizing Self-Regulatory Organizations (SROs) for regulated entities. This framework contains broad parameters such as objectives, responsibilities, eligibility criteria, governance standards, application process, and other basic conditions for granting recognition.
  • Sector-Specific Guidelines: Sector-specific guidelines will be issued separately by the respective departments of the Reserve Bank for each sector where an SRO is intended to be set up. This ensures that the SROs cater to the specific needs and requirements of their respective sectors.
  • Draft Framework and Public Consultation: A draft framework for SROs was issued for public comments, and based on the examination of inputs received, the omnibus framework has been finalized. This indicates a consultative approach in the development of the SRO framework.
  • Credibility and Responsibility: SROs are expected to operate with credibility, objectivity, and responsibility under the oversight of the regulator. They aim to improve regulatory compliance for the healthy and sustainable development of the sectors they cater to.
  • Transparency and Independence: SROs are expected to operate with transparency, professionalism, and independence to foster greater confidence in the integrity of the sector. Compliance with the highest standards of governance is a prerequisite for an effective SRO.

The significance of Self-Regulatory Organizations (SROs)-

  • Enhanced Regulatory Compliance: SROs establish and enforce industry standards and best practices, leading to improved regulatory compliance among member organizations. By setting clear guidelines and monitoring adherence to them, SROs help regulated entities maintain compliance with relevant laws and regulations.
  • Industry Integrity and Confidence: SROs play a crucial role in maintaining and enhancing industry integrity and public confidence. By promoting transparency, professionalism, and ethical conduct, SROs contribute to building trust among stakeholders, including customers, investors, and regulatory authorities.
  • Tailored Regulation: SROs can develop sector-specific regulations and standards that are tailored to the unique characteristics and challenges of their respective industries. This flexibility allows SROs to address industry-specific issues effectively, leading to more efficient regulation.
  • Effective Self-Regulation: SROs enable industry participants to self-regulate by collaboratively developing and enforcing rules and standards. This approach can often be more responsive and adaptable than traditional government regulation, as SROs can quickly respond to emerging risks and market developments.
  • Reduced Regulatory Burden: SROs can help alleviate the regulatory burden on government agencies by taking on certain regulatory functions. By delegating responsibilities such as rule-making, monitoring, and enforcement to SROs, regulators can focus their resources on overseeing broader market activities and addressing systemic risks.
  • Innovation and Growth: SROs can foster innovation and growth within their industries by creating a supportive regulatory environment. By providing guidance on emerging technologies and business models, SROs can encourage innovation while ensuring that it aligns with regulatory requirements and consumer protection standards.
  • Expertise and Knowledge Sharing: SROs serve as repositories of industry expertise and knowledge, allowing members to benefit from collective insights and experiences. Through networking events, training programs, and knowledge-sharing initiatives, SROs facilitate collaboration and learning among industry participants.

Conclusion-

Self-Regulatory Organizations (SROs) enhance compliance, integrity, and tailored regulation. They enable effective self-regulation, reduce regulatory burden, foster innovation, and facilitate expertise sharing, ensuring sustainable industry growth and integrity.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI and SEBI: India’s Financial Landscape under Scrutiny

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RBI, SEBI and their regulatory functions

Mains level: NA

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

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI may move some NBFCs to Top Layer this year

Note4Students

From UPSC perspective, the following things are important :

Prelims level: NBFCs and their operations, Scale-Based Regulation of NBFCs

Mains level: NA

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

 

Post your answers here.
0
Please leave a feedback on thisx

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Discussions to lower CRR on Green Deposits

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Green Deposits

Mains level: Read the attached story

Introduction

  • State Bank of India (SBI) is in talks with the Reserve Bank of India (RBI) to reduce the cash reserve ratio (CRR) requirement on green deposits.

What are Green Deposits?

  • Definition: Green deposits are fixed-term investments tailored for individuals and entities seeking to support environmentally friendly initiatives.
  • ESG Investing: These deposits align with the principles of Environmental, Social, and Governance (ESG) investing, reflecting a growing trend towards sustainable finance.
  • Utilization: Funds from green deposits are directed towards projects promoting renewable energy, clean transportation, pollution control, green infrastructure, and sustainable water management.

RBI Framework for Green Deposits

  • Preventing Greenwashing: The RBI’s framework ensures transparency in environmental claims associated with green deposits.
  • Deposit Options: Banks offer green deposits denominated in rupees, with choices between cumulative or non-cumulative options.
  • Applicability: Scheduled commercial banks, small finance banks, non-banking financial companies (NBFCs), and housing finance companies (HFCs) must comply with this framework.
  • Eligibility: Both corporate entities and individual customers can invest in green deposits, contributing to environmentally sustainable initiatives.
  • Allocation: Funds mobilized through green deposits are directed towards sectors such as renewable energy, waste management, and afforestation.
  • Restrictions: Lenders are prohibited from channelling green deposit funds into sectors like fossil fuels, nuclear power, or tobacco.
  • Verification: Independent Third-Party Verification is conducted annually to assess the allocation and impact of funds raised through green deposits.
  • Oversight: Lenders are required to review the impact of funds lent for green finance activities on an annual basis.
  • Penalties: There are no penalties for underutilization of funds raised through green deposits, providing flexibility to financial institutions.

Distinguishing Green Deposits from Normal Deposits

  • Project Allocation: Green deposits allocate funds to specific environmentally friendly projects, unlike regular deposits.
  • Interest Rates: Interest rates on green deposits are determined by lenders and are currently comparable to those offered on conventional deposits.

Back2Basics: Cash Reserve Ratio (CRR)

  • Banks are mandated to maintain a certain portion of their deposits and specific liabilities in liquid cash with the RBI.
  • CRR serves as a crucial tool in the RBI’s arsenal for managing liquidity in the economy and acts as a safety net during times of banking stress.
  • Currently, banks are required to uphold 4.5% of their Net Demand and Time Liabilities as CRR with the RBI.
  • Incremental-CRR was introduced on August 10, 2023, as a temporary measure by RBI to absorb surplus liquidity.
  • Banks were required to maintain an I-CRR of 10% on the increase in their Net Demand and Time Liabilities (NDTL) between May 19, 2023, and July 28, 2023.
  • It came into effect from the fortnight starting August 12, 2023.
  • ICRR is employed during periods characterized by excess liquidity in the financial system.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Payments Banks: A Closer Look at Their Features and Objectives

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Payments Banks

Mains level: Read the attached story

Introduction

  • The Reserve Bank of India (RBI) imposed additional curbs on Paytm Payments Bank Ltd (PPBL), prohibiting it from operating its mobile wallet after February.
  • This article provides insights into what payments banks are, their objectives, features, and the regulatory framework governing them.

Understanding Payments Banks

  • Definition: Payments banks are financial institutions similar to regular banks but operate on a smaller scale without engaging in credit risk.
  • Origin: The concept of payments banks was recommended by the Nachiket Mor Committee.
  • Objective: The primary goal is to advance financial inclusion by providing banking and financial services to unbanked and underbanked areas, catering to migrant laborers, low-income households, small entrepreneurs, and more.
  • Legal Framework: Payments banks are registered as public limited companies under the Companies Act 2013 and licensed under Section 22 of the Banking Regulation Act 1949.
  • Regulation: They are governed by various legislations, including the Banking Regulation Act, 1949; RBI Act, 1934; Foreign Exchange Management Act, 1999, among others.

Key Features of Payments Banks

  • Differentiation: Payments banks are distinct entities, not universal banks.
  • Scale: They operate on a smaller scale compared to traditional banks.
  • Capital Requirements: Payments banks are required to have a minimum paid-up equity capital of 100 crores.
  • Promoter Contribution: The promoter must contribute at least 40% of the paid-up equity capital for the first five years from the commencement of business.

Permissible Activities

  • Accept deposits up to Rs. 2,00,000.
  • Offer demand deposits in the form of savings and current accounts.
  • Invest deposits in secure government securities as Statutory Liquidity Ratio (SLR), accounting for 75% of the demand deposit balance.
  • Place the remaining 25% as time deposits with other scheduled commercial banks.
  • Provide remittance services, mobile payments/transfers/purchases, ATM/debit cards, net banking, and third-party fund transfers.
  • Act as a banking correspondent (BC) for other banks to offer credit and services beyond their capabilities.

Activities Not Permitted

  • Loans and Credit Cards: Payments banks cannot issue loans and credit cards.
  • Time and NRI Deposits: They are not authorized to accept time deposits or NRI deposits.
  • Non-Banking Subsidiaries: Payments banks cannot establish subsidiaries to engage in non-banking financial activities.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s guidelines on State ‘Guarantees’ on Borrowings

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Sovereign 'Guarantee'

Mains level: Not Much

Introduction

  • A working group constituted by the Reserve Bank of India (RBI) has presented key recommendations to address challenges related to guarantees extended by State governments.

Understanding ‘Guarantee’

  • A ‘guarantee’ involves a legal obligation for a State to make payments on behalf of a borrower, safeguarding investors/lenders from default risks.
  • As defined by the Indian Contracts Act (1872), it is a contract involving three parties: the principal debtor, creditor, and surety (State government).
  • The ‘guarantee’ acts as a safety net, ensuring payment in case of default by the borrower.

Purpose of ‘Guarantee’ at the State Level

  • Sovereign Guarantee: Facilitates concessional loans from bilateral or multilateral agencies to public sector enterprises.
  • Project Viability: Enhances project viability for activities with significant social and economic benefits.
  • Resource Mobilization: Enables public sector enterprises to secure resources at favorable terms, contributing to lower interest charges.

Fiscal Risks and Working Group Recommendations

  • Cash Outflows and Debt: While guarantees may not require upfront cash payments, they pose fiscal risks, leading to unanticipated cash outflows and increased debt during challenging times.
  • Complex Estimation: Estimating the quantum and timing of potential costs/cash outflows is challenging due to triggers associated with guarantees.

Recommendations on ‘Guarantee’ Definition and Guidelines

  • Broadened Definition: The term ‘guarantee’ should encompass all instruments creating obligations for the guarantor (State) to make future payments on behalf of the borrower.
  • Guidelines for Accordance: Government guarantees should not substitute budgetary resources and should adhere to Government of India guidelines.
  • Preconditions: Specify preconditions, including the period of guarantee, guarantee fee, government representation on the management board, and audit rights.

Risk Determination, Fee, and Ceiling

  • Risk Weight Assignment: States should assign risk weights (high, medium, low) before extending guarantees, considering past defaults.
  • Ceiling on Guarantees: A desirable ceiling for incremental guarantees during a year, limiting stress on state governments.
  • Guarantee Fee Structure: Reflective of borrower’s project riskiness and activities, with a base fee of at least 2.5% per annum.

Disclosures and Honouring Commitments

  • Credit Disclosure: Banks/NBFCs should disclose credit extended to State-owned entities backed by State guarantees for improved credibility.
  • Database Establishment: Set up a state-level unit to track and consolidate all guarantees, ensuring proper data compilation.
  • Timely Honouring: States must honor guarantees without delay, recognizing the reputational and legal risks associated with defaults.

Conclusion

  • The RBI working group’s recommendations aim to fortify fiscal management by introducing standardized practices, enhancing risk assessment, and ensuring transparent disclosures.
  • These measures, if implemented, can contribute to better fiscal discipline and mitigate potential risks associated with state government guarantees.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

India’s 1991 Crisis and the RBI Governor’s Role

Note4Students

From UPSC perspective, the following things are important :

Prelims level: BOP Crisis, LPG Reforms

Mains level: Read the attached story

S. Venkitaramanan, former Governor of the RBI

Central Idea

  • S. Venkitaramanan, former Governor of the Reserve Bank of India (RBI), passed away, leaving behind a legacy of significant contributions.
  • His tenure is marked by crucial interventions during India’s economic crises and a commitment to open dialogue and innovative policies.

Navigating the Balance of Payments Crisis

  • Economic Turbulence in 1990: India faced a severe balance of payments crisis due to reduced remittances and increased oil prices.
  • Critical Measures: Under Venkitaramanan’s leadership, the RBI took bold steps, including pledging gold reserves, to avert a default on international payments.
  • Impact of Gold Pledging: This move, though criticized domestically, was crucial in maintaining India’s international credibility and financial stability.

Role in Economic Reforms

  • Import Compression Strategy: Venkitaramanan initiated a program of import compression, significantly reducing the current account deficit.
  • Foundation for Future Reforms: These measures laid the groundwork for the economic reforms introduced by the Narasimha Rao government and Dr. Manmohan Singh.

Challenges and Controversies

  • The Harshad Mehta Scam: Venkitaramanan’s tenure was marred by the securities scandal involving Harshad Mehta, overshadowing his earlier achievements.
  • Public Perception: Despite his significant contributions, the public memory often overlooks his role in steering India through economic turmoil.

Remarkable Openness and Inclusivity

  • Engagement with Diverse Opinions: Venkitaramanan was known for his openness to different viewpoints, engaging with economists and critics alike.
  • Innovative Approach to Policy Making: His willingness to consider varied perspectives contributed to more inclusive and effective economic policies.

Legacy in the RBI and Beyond

  • Establishment of the Development Research Group: Venkitaramanan’s vision led to the creation of this group, aiming to foster interaction between the RBI and independent economists.
  • Influence on Current Economic Policies: His belief in relying on India’s intellectual resources continues to influence the RBI’s approach, though challenges like inflation management persist.

Conclusion

  • Enduring Impact: S. Venkitaramanan’s tenure as RBI Governor was marked by courageous decisions and a commitment to intellectual openness.
  • Remembering His Contributions: While his term had its challenges, his role in safeguarding India’s economy and fostering a culture of dialogue and research within the RBI remains a significant part of his legacy.
  • Inspiration for Future Leaders: His approach to economic policy and management continues to serve as an inspiration for current and future leaders in the field.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI enhances Digital Payment Security with CoFT through Banks

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Card-on-File Tokenisation (CoFT)

Mains level: Read the attached story

Central Idea

  • The Reserve Bank of India (RBI) has expanded the scope of card-on-file tokenisation (CoFT) services to include card-issuing banks and institutions, enhancing the security of digital payments.
  • Previously, tokenisation services were primarily provided through merchants. The RBI’s recent notification marks a significant shift in this approach.

Understanding CoFT and Its Importance

  • Card-on-File (CoF) Concept: Traditionally, merchants stored customer card details (CoF) on their platforms, posing risks to financial data security.
  • Tokenisation Solution: To mitigate data breach risks, the RBI introduced tokenisation, where a unique token replaces actual card details at the merchant’s end.
  • Regulatory Measures: In March 2020, RBI mandated that payment aggregators and merchants should not store actual card data, aiming to minimize system vulnerabilities. The deadline for compliance was extended to December 2021 following industry requests.

Implementation of CoFT by Card Issuers

  • Channels for Token Generation: Customers can generate CoFT tokens through mobile and internet banking, offering a convenient and secure method for digital transactions.
  • Consent and Authentication: Token generation requires explicit customer consent and Additional Factor of Authentication (AFA) validation, ensuring user control and security.
  • Flexibility for Cardholders: Cardholders have the flexibility to tokenise their cards at any time and select specific merchants for maintaining tokens.
  • Token Issuance: The tokens can be issued either by the card network, the issuer, or both, providing multiple layers of security.

Impact and Adotion of CoFT

  • Enhancing Safety and Convenience: CoFT aims to secure card data without compromising the convenience of card transactions.
  • Implementation Timeline: The RBI introduced CoFT in 2021, with full rollout from October 1, 2022.
  • Usage Statistics: Since its implementation, over 56 crore tokens have been created, facilitating transactions worth over ₹5 lakh crore.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

3 reasons why the RBI has held interest rates steady

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Monetary Policy Committee (MPC)

Mains level: RBI's use of measures like an incremental cash reserve ratio and open market sales to manage liquidity

RBI MPC may maintain the status quo on August 10; comment on inflation,  growth trajectory to be in focus | Mint

Central idea 

The RBI’s recent monetary policy decision maintains a cautious stance, driven by concerns over persistent food inflation and global central banks signaling higher interest rates. Despite a positive economic outlook, challenges include incomplete transmission of past rate hikes and potential risks from interconnectedness between banks and non-banks.

Key Highlights:

  • The Reserve Bank of India (RBI) maintained its pause on monetary policy and retained the withdrawal-of-accommodation stance.
  • Reasons for the decision include ongoing concerns about inflation, particularly in critical food items, despite a recent decrease.
  • Influences from systemically important central banks, such as the US Federal Reserve and the European Central Bank, impact India’s monetary policy.

Key Challenges:

  • Persistent risks from food inflation, driven by factors like an uneven monsoon and global food supply uncertainties.
  • Impact of higher interest rates signaled by central banks like the US Federal Reserve and the European Central Bank on India’s economy.
  • Incomplete transmission of past rate hikes into lending rates poses challenges for the RBI.

Key Terms:

  • Monetary Policy Committee (MPC): A committee responsible for framing India’s monetary policy.
  • Core CPI Inflation: Consumer Price Index inflation excluding volatile food and fuel components.
  • Macroprudential Tools: Measures used by central banks to ensure the stability of the financial system.

Key Phrases:

  • “The battle against inflation is far from over.”
  • “Systemically important central banks signal higher-for-longer interest rates.”
  • “Transmission of past rate hikes into lending rates remains incomplete.”

Key Quotes:

  • “The RBI expects consumer inflation at 5.4 per cent this fiscal, while our forecast is slightly higher at 5.5 per cent.” (Authors)
  • “The RBI Governor flagged increasing interconnectedness between banks and non-banks, raising the possibility of stress contagion.” (RBI Governor)

Key Statements:

  • “Despite rate increases, bank credit growth has sustained over 15 per cent this fiscal, unchanged from last year.”
  • “India will continue to be a growth outperformer among large economies this fiscal.”

Key Examples and References:

  • Influence of US Federal Reserve and European Central Bank’s higher interest rates on global monetary policies.
  • RBI’s use of measures like an incremental cash reserve ratio and open market sales to manage liquidity.

Key Facts and Data:

  • RBI’s forecast for consumer inflation: 5.4 per cent.
  • GDP growth forecast lifted to 7 per cent for the fiscal year.

Critical Analysis:

  • Emphasizes ongoing concerns about inflation, particularly in critical food items.
  • Highlights the impact of global central banks’ policies on India’s monetary decisions.
  • Raises the challenge of incomplete transmission of rate hikes into lending rates.

Way Forward:

  • Monitor and address risks related to food inflation and global interest rate dynamics.
  • Continue using measures like liquidity management and macroprudential tools for financial stability.
  • Assess and manage potential challenges arising from the interconnectedness of banks and non-banks.
  • Anticipate and address the impact of rising interest rates on India’s economy.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What RBI’s increase in Risk Weights mean to the borrower?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Risk Weights

Mains level: NA

Central Idea

  • The Reserve Bank of India (RBI) recently raised risk weights for unsecured loans, including credit cards, consumer durable loans, and personal loans.
  • Risk weights for bank lending to non-banking finance companies (NBFCs) serving this segment were increased to 125% from the existing 100%.

What are Risk Weights?

  • Capital Implication: Every rupee lent by a bank has an impact on its capital position.
  • Attribution to Risk: Risk weights are assigned to loans and assets based on their nature and associated risk.
  • Capital Coverage: Banks must ensure that their capital is sufficient to cover these risk-weighted assets.
  • Varying Risk Weights: Different asset classes have varying risk weights. For example, home loans may have risk weights ranging from 50% to 75%, while corporate loans are assigned 100% risk weight.

How does it impact Borrowers?

  • Interest Rates: Lower risk weights result in lower interest rates for borrowers. This principle guides the pricing of loans.
  • Examples: Home loans generally have lower interest rates due to their lower risk weights, while personal loans and credit cards carry higher interest rates due to their risk profile.

RBI Decision: Concerns about Consumer Loans

  • Rising Share: Unsecured loans have seen rapid growth, constituting 10% of the banking system’s portfolio.
  • Fastest-Growing Segment: This segment has been the fastest-growing in recent years.
  • Unsecured Nature: Loans like consumer durable loans lack income-generating assets, making it challenging to ascertain borrowers’ true repayment capacity.
  • Granular Nature: While small-ticket in nature, the significant growth in this segment has raised regulatory concerns.

https://www.thehindubusinessline.com/blexplainer/bl-explainer-what-rbis-increase-in-risk-weights-mean-to-the-borrower/article67554070.ece

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

How former RBI governor S Venkitaramanan helped steer India out of the balance of payment crisis

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RBI governor

Mains level: leadership during a critical financial period

Former RBI Governor S. Venkitaramanan Passed Away At 92

Central idea

S Venkitaramanan, as RBI Governor, navigated a challenging financial landscape, implementing innovative measures, including pledging gold reserves, to overcome a critical balance of payment crisis exacerbated by the Iraq-Kuwait War. His leadership traits, commitment to reform, and resilience in dynamic political shifts define his impactful legacy

Key Highlights:

  • Historical Interaction with S Venkitaramanan: The author shares a personal connection with S Venkitaramanan dating back to the late 1980s when they worked together in the Reserve Bank of India (RBI). Venkitaramanan, at that time, was the Finance Secretary in the government of India.
  • Challenges Faced by Venkitaramanan as RBI Governor: Venkitaramanan assumed the role of RBI Governor during a challenging period marked by a critical balance of payment problem, intensified by the Iraq-Kuwait War. The situation demanded unconventional measures, including shipping gold reserves to raise foreign exchange.
  • Extraordinary Steps Taken: To address the balance of payment crisis, the RBI, under Venkitaramanan’s leadership, borrowed around USD 405 million by pledging gold reserves kept outside India. This unusual step showcased determination and innovation in navigating a complex financial scenario.
  • Dynamic Political Environment: The backdrop of frequent changes in the central government added complexity to the financial responsibilities of the RBI and its governor. Venkitaramanan played a crucial role in tapping international financial institutions and raising the necessary foreign exchange.
  • Role of IMF and Devaluation of Rupee: The RBI, led by Venkitaramanan, approached the International Monetary Fund (IMF) for assistance. The initial request was related to the Compensatory and Contingency Financing Facility (CCFF), providing limited conditionalities. Additionally, the government, in consultation with the RBI, decided to devalue the rupee sharply in two steps in June 1991.
  • Reform Initiatives: Venkitaramanan was a reformer who initiated banking sector reforms and introduced changes in the exchange rate system, moving towards a dual exchange rate. He advocated for a strong role for public sector enterprises where efficiency could be maintained.
  • Leadership Traits: Venkitaramanan’s leadership qualities included a sharp mind, the ability to cut through complex problems, a willingness to listen to diverse viewpoints, and courage in making crucial decisions.

Key Challenges:

  • Balance of Payment Crisis: Venkitaramanan faced a critical balance of payment problem aggravated by external factors such as the Iraq-Kuwait War. The challenge was to bridge the financial gap and avoid default in payment obligations.
  • Dynamic Political Changes: Frequent changes in the central government added an additional layer of complexity to financial decision-making. Venkitaramanan navigated these changes while fulfilling the responsibilities of the RBI.

Key Terms and Phrases:

  • Compensatory and Contingency Financing Facility (CCFF): An IMF facility created to aid countries facing sudden rises in the price of imported commodities or a sudden fall in export prices. The RBI approached the IMF for assistance, initially focusing on the CCFF.
  • Dual Exchange Rate System: Venkitaramanan initiated a shift towards a dual exchange rate system, marking a significant change in the country’s approach to managing its currency’s value.
  • Gold Pledging to Raise Foreign Exchange: The RBI, under Venkitaramanan, borrowed around USD 405 million by pledging gold reserves kept outside India during the balance of payment crisis.

Critical Analysis:

  • Innovative Leadership in Crisis: Venkitaramanan’s decision to ship gold reserves and explore unconventional measures showcased innovative leadership during a financial crisis, preventing a default in payment obligations.
  • Navigating Political Changes: Managing financial responsibilities amid frequent changes in the central government demonstrated Venkitaramanan’s ability to navigate a dynamic political environment, ensuring financial stability.
  • Reform Initiatives for Financial Resilience: Venkitaramanan’s focus on banking sector reforms and a dual exchange rate system aimed at enhancing financial resilience during turbulent times, showcasing a forward-looking approach.

Way Forward:

  • Building on Reform Initiatives: Advocate for building on the reform initiatives introduced by Venkitaramanan, emphasizing the importance of a resilient financial system in navigating future economic challenges.
  • Continued Collaboration with International Institutions: Encourage continued collaboration with international financial institutions to strengthen India’s economic resilience, leveraging lessons learned from Venkitaramanan’s innovative approaches.
  • Maintaining a Prudent Financial Policy: Emphasize the importance of prudent financial policies, considering both domestic and international factors, to ensure stability and resilience in the face of economic uncertainties.

Balanced Diplomatic Conclusion for good marks:

S Venkitaramanan’s leadership during a critical financial period exemplifies courage, innovation, and resilience. Acknowledging his contributions, the nation can build on reform initiatives, collaborate globally, and maintain prudent financial policies for a stable and resilient economic future.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Open market operations can help resist pressure on the Indian rupee. Should it be resisted?

 

Central idea

The article explores the unexpected move by the RBI to consider open market operations (OMOs) for liquidity management, questioning its consistency with inflation concerns. It delves into factors like rapid credit growth and currency stability, suggesting a broader motivation behind the tightening measures.

What’s Open Market Operations (OMOs) and Why Does It Matter?

  • OMOs Explained: OMOs are like a trick the RBI uses to manage how much money is floating around. They might buy or sell government bonds to control the amount of cash in the system.
  • Why It Matters: It matters because the RBI wants to make sure there’s not too much money in the market, which can lead to other problems like inflation.

Is It Making Sense? Questioning the Money Moves

  • Inflation Confusion: When the RBI talks about doing OMOs but inflation is not skyrocketing, it might make us scratch our heads. We wonder, why mess with the money flow if inflation is not going crazy?
  • Asking Questions: It’s like asking your friend why they are using an umbrella on a sunny day. We want to understand if OMOs make sense when things seem okay.

Key Highlights:

  • October MPC Meeting: Unanimous decision to maintain unchanged interest rates, meeting expectations.
  • OMOs Announcement: RBI Governor hints at open market operations (OMOs) for liquidity management, causing a 12 basis points surge in the 10-year government bond yield.
  • Inflation Trends: Retail inflation surged in July and August due to soaring vegetable prices. Despite a sharp fall to 5% in September, inflation remains above the central bank’s upper threshold.
  • Inflation Projections: RBI maintains its inflation projections at 5.4% for 2023-24 and 5.2% for Q1 2024-25, indicating confidence in the trajectory.
  • Core Inflation Eases: Core inflation (excluding food and fuel components) has eased from its peak, dropping to 4.7% in September.
  • Credit Growth Surprise: Sharp rise in retail and personal loans, raising concerns about the pace and quality of credit growth.
  • UBS Study: Reveals a significant increase in borrowers with multiple personal loans, with 7.7% having more than five loans by March 2023.
  • RBI’s Response to Credit Growth: Concerns prompt discussions about squeezing liquidity and de facto tightening through interest rate adjustments.
  • OMOs as Currency Defense: OMOs considered a tool to increase the spread between Indian and US bond yields, easing pressure on the Rupee.

Challenges and Concerns:

  • Inflation: Persistent inflation above the central bank’s upper threshold raises concerns about economic stability.
  • Credit Growth: Rapid rise in retail and personal loans prompts concerns about the quality of borrowers and potential stress in this segment.
  • Currency Pressure: Global economic dynamics, including the strengthening USD, pose challenges to the stability of the Rupee.
  • Foreign Currency Reserves: Decline in foreign currency assets raises questions about the sustainability of currency defense.
  • Liquidity Tightening: OMOs and potential de facto tightening measures may impact liquidity conditions, affecting both consumer and industrial credit.

Analysis of the article:

  • RBI’s Strategy: The use of OMOs raises questions about the alignment with the traditional stance of monetary policy, indicating potential broader motivations.
  • Credit Growth Impact: Concerns over the sharp rise in credit prompt discussions about strategies to slow down its growth, including liquidity tightening.
  • Currency Defense: The RBI’s intervention in currency markets and the consideration of OMOs reflect efforts to stabilize the Rupee amidst global economic shifts.

Key Data:

  • Inflation Figures: Retail inflation spiked in July and August, falling to 5% in September.
  • Inflation Projections: RBI maintains projections at 5.4% for 2023-24 and 5.2% for Q1 2024-25.
  • Core Inflation: Eased to 4.7% in September.

 

  • UBS Study Findings: Share of borrowers with more than five personal loans rose to 7.7% by March 2023.
  • Foreign Currency Asset Decline: RBI’s foreign currency assets fell by around $25 billion since July.

Economic Key Terms:

  • Open Market Operations (OMOs): Financial maneuvers involving buying and selling assets to manage liquidity.
  • Inflation Targeting Framework: Central bank’s approach to maintaining a specific inflation rate.
  • Core Inflation: Inflation measure excluding volatile components like food and fuel.
  • Credit Growth: The rate at which the total outstanding loans in the economy increase.
  • Currency Intervention: Central bank’s actions to influence the value of its currency in the foreign exchange market.
  • Foreign Currency Reserves: Holdings of other countries’ currencies by a central bank.
  • Liquidity Tightening: Measures to reduce the availability of money in the financial system.
  • Interest Rate Projections: Central bank’s forecasts for future interest rates based on economic conditions.

The RBI’s unconventional use of open market operations suggests a strategic response to challenges in inflation, credit growth, and currency stability. Balancing tightening measures with sustaining economic momentum poses a nuanced dilemma. The evolving global dynamics cast uncertainty on the longevity of these financial strategies.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s new rules on Credit Information

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Credit Information Companies (CICs), Credit Score

Mains level: Read the attached story

Central Idea

  • When you apply for a loan, your credit score becomes a crucial factor. It’s determined by your debt and your history of repayments.
  • In a significant move, the Reserve Bank of India (RBI) has issued directives to credit information companies (CICs) regarding the transparency of accessing your Credit Information Report (CIR).

RBI’s Directive on CIR Access

  • Notification to Customers: CICs are now mandated to notify customers via SMS or email when banks and non-banking finance companies (NBFCs) access their Credit Information Report (CIR).
  • Alerts on Default Information: Credit institutions, including banks and NBFCs, must also send SMS or email alerts to customers when they submit information to CICs regarding defaults or Days Past Due (DPD) on existing credit.
  • Implementation Timeline: These new rules are set to take effect within six months.

Understanding Credit Information Companies (CICs)

  • CIC Function: CICs maintain and analyze credit information of individuals and businesses, which is provided by banks and NBFCs.
  • Credit Scores and Ranks: Based on this data, CICs calculate credit scores for individuals and credit ranks for companies to assess their creditworthiness and credit history.
  • Impact on Loan Approval: A high credit score often leads to more favorable loan terms, while a low score, possibly due to previous loan defaults, can hinder loan or credit card approval.

Accessing Your Credit Score

  • Payment Requirement: Typically, individuals can obtain their credit scores from CICs for a fee.
  • RBI’s Directive: The RBI has now directed CICs to provide a “Free Full Credit Report (FFCR),” which includes the credit score, once every calendar year to individuals whose credit history is available with the CIC.
  • Convenient Access: The link to access the FFCR must be prominently displayed on the CIC’s website for easy access.

Data Accuracy Concerns

  • Correction of Data: If a customer believes that their credit information is incorrect, they can request a correction.
  • Reason for Rejection: Banks and NBFCs are required to inform customers about the reasons for rejecting their data correction requests, facilitating a better understanding of the issues in the CIR.

CIC Accountability and Transparency

  • Review of ‘Search & Match’ Logic: CICs must conduct a periodic review, at least semi-annually, of their ‘search & match’ logic algorithm used to generate borrowers’ CIRs.
  • Root Cause Analysis: A “root cause analysis” of complaints should identify issues in the algorithm.
  • Board Approval: Results and changes resulting from the analysis should be presented to the CIC’s Board of Directors for review.
  • Timely Data Ingestion: CICs must ingest credit information data from banks and NBFCs within seven calendar days of receipt.
  • Disclosure of Complaints: CICs are required to disclose details of complaints registered against them and credit institutions on their websites.

Conclusion

  • RBI’s recent directives aim to enhance transparency, accountability, and consumer empowerment in the credit information ecosystem.
  • Customers will receive alerts regarding access to their credit information, and CICs are encouraged to ensure data accuracy and promptly address customer concerns.
  • These changes will likely improve the credit assessment process and provide individuals with better control over their financial data.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s $5 Billion Forex Swap Matures

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Forex Swap

Mains level: Not Much

Central Idea

  • As a $5 billion forex swap between the Reserve Bank of India (RBI) and banks approaches maturity, it signifies the central bank’s strategic move to manage liquidity and mitigate inflationary pressures.

What is RBI’s Forex Swap?

  • Forex Tool: The Dollar–Rupee Swap is a forex tool employed by the RBI to exchange its currency with banks for another currency.
  • Buy/Sell Swap: It involves two variants: Dollar–Rupee Buy/Sell Swap, where the RBI buys dollars from banks in exchange for Indian Rupees, and then commits to selling the dollars back at a later date.
  • Sell/Buy Swap: Conversely, the RBI may sell dollars, thereby withdrawing an equivalent sum in rupees, reducing liquidity in the financial system.
  • Risk Mitigation: These swap operations are characterized by predetermined transaction terms, eliminating exchange rate and market risks.

The Strategy behind

  • USD 5 Billion Swap: The RBI initiated a USD 5.135 billion swap with banks and aims to repurchase the dollars at the lowest possible premium after a two-year tenor.
  • Lower Range Bids: Banks bidding at the lower end of the premium range are more likely to succeed in the auction.

Rationale for RBI’s Action

  • Surplus Liquidity: The Indian financial system currently experiences surplus liquidity, amounting to Rs 7.5 lakh crore, necessitating measures to curb potential inflation.
  • Traditional Tools: Traditional methods like increasing the repo rate or Cash Reserve Ratio (CRR) can negatively impact the economy and may not lead to complete transmission of monetary policy.
  • Previous Toolkit: The RBI used Variable Rate Reverse Repo Auction (VRRR) but encountered under-subscription due to better yields in the cash market.
  • Longer-Term Strategy: As a result, the RBI opted for forex auctions as a longer-term liquidity adjustment tool.

Impact of the Swap

  • Liquidity Reduction: The primary effect is the reduction of liquidity, which currently stands at an average of Rs 7.6 lakh crore.
  • Strengthening Rupee: Increased dollar inflow will strengthen the Indian Rupee, which has already appreciated against the US dollar.
  • Inflation Control: The RBI typically tightens liquidity when inflation risks are elevated. Factors contributing to inflation include rising oil prices due to the Russia-Ukraine conflict and foreign portfolio investors withdrawing funds from Indian stocks.

Conclusion

  • The RBI’s forex swap strategy emerges as a strategic tool to manage liquidity, stabilize the currency, and control inflationary pressures.
  • By reducing system liquidity and strengthening the rupee, the central bank aims to navigate the challenges posed by global events and ensure economic stability in India.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to unveil Card-on-File Tokenisation (CoFT)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Card-on-File Tokenisation (CoFT)

Mains level: Not Much

Tokenisation

Central Idea

  • The Reserve Bank of India (RBI) has embarked on a mission to revolutionize digital payments in the country by proposing the introduction of Card-on-File Tokenisation (CoFT).
  • This move, aimed at enhancing convenience for cardholders, is set to redefine the way Indians engage in online transactions.

Card-on-File Tokenisation (CoFT)

  • Card-on-file tokenisation involves replacing actual credit and debit card details with an alternative code known as a “token.”
  • This token is unique for a specific combination of card, token requestor, and device.
  • Each token is distinct and tailored to the combination of the card, token requestor (the entity facilitating tokenisation), and the merchant (which may or may not be the same as the token requestor).
  • The primary advantage of Card-on-File Tokenisation is enhanced security.
  • During a tokenised card transaction, the actual card details are not disclosed to the merchant.
  • This shields sensitive information from potential security breaches during transaction processing.
  • Customers who have not enabled tokenisation will need to manually input their name, 16-digit card number, expiry date, and CVV (Card Verification Value) each time they make an online purchase.

Back2Basics: Card-on-File Transaction

  • A Card-on-File transaction occurs when cardholders authorize merchants to securely store their payment information.
  • This stored data is then used to bill the cardholders’ accounts for future purchases.
  • It simplifies the checkout process for consumers, offering convenience and efficiency.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Story of Mahatma Gandhi’s Portrait on Indian Banknotes

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Mahatma Gandhi

Mains level: Read the attached story

gandhi

Central Idea

  • Mahatma Gandhi seems a natural choice for the face of Indian currency as the Father of the Nation.
  • This wasn’t until 1996 that his image became a permanent fixture on legal banknotes issued by the RBI, the nation’s central bank and regulatory authority for the Indian banking system.
Gandhi
1946 photograph featuring Gandhi Ji with Frederick William Pethick-Lawrence

Gandhi’s Portrait on Indian Currency

  • Photographic Source: The portrait of Gandhi on Indian banknotes is not a caricature but a cut-out from a 1946 photograph featuring him alongside British politician Lord Frederick William Pethick-Lawrence.
  • Expression Matters: This particular photograph was chosen for its ideal depiction of Gandhi’s smiling visage, and the portrait is a mirrored image of the cut-out.
  • Unknown Photographers: Interestingly, the identities of the photographer of this image and the person who selected it remain unknown.

Currency Design Process

  • RBI’s Responsibility: The RBI’s Department of Currency Management is tasked with designing rupee notes, subject to approval from the central bank and the Union government.
  • Regulatory Framework: Section 25 of the RBI Act, 1934, mandates that the design, form, and material of banknotes must be approved by the central government after considering the central board’s recommendations.

Gandhi’s Debut on Indian Currency

  • 1969 Commemoration: Gandhi made his first appearance on Indian currency in 1969 through a special series issued to commemorate his 100th birth anniversary. These notes, featuring Gandhi alongside the Sevagram Ashram, bore the signature of RBI governor LK Jha.
  • 1987 Inclusion: In October 1987, a series of Rs 500 currency notes featuring Gandhi was introduced.

The Transition to Independent India’s Banknotes

  • Post-Independence Currency: Initially, after India gained independence in August 1947, the RBI continued to issue notes from the colonial era that depicted King George VI.
  • Symbol Selection: The government of India introduced new 1-rupee notes in 1949, replacing King George with a representation of the Lion Capital of Ashoka Pillar at Sarnath.
  • Design Continuity: The subsequent release of banknotes in 1950, in denominations of Rs 2, 5, 10, and 100, featured the Lion Capital watermark, maintaining continuity with earlier designs.

Gandhi’s Permanence on Banknotes

  • Security Concerns in the 1990s: By the 1990s, the RBI recognized the need for enhanced security features on currency notes due to advancements in reprographic techniques. A human face was deemed less susceptible to forgery than inanimate objects.
  • Gandhi’s Enduring Appeal: Mahatma Gandhi’s national significance made him the ideal choice. In 1996, the RBI introduced a new ‘Mahatma Gandhi Series’ of banknotes, replacing the previous Ashoka Pillar notes and incorporating advanced security features.
  • Continuity in 2016: The ‘Mahatma Gandhi New Series’ of banknotes, introduced in 2016, continued to feature Gandhi’s portrait, with the addition of the Swachh Bharat Abhiyan logo and enhanced security elements.

Other Suggestions for Currency Faces

  • Varied Proposals: Over the years, there have been calls to feature different personalities on banknotes apart from Gandhi.
  • Lord Ganesha and Goddess Lakshmi: In October 2022, Delhi Chief Minister Arvind Kejriwal appealed to the Prime Minister and the Union government to include images of Lord Ganesha and goddess Lakshmi on currency notes.
  • Previous Proposals: Suggestions in the past included Noble Laureate Rabindranath Tagore and former President APJ Abdul Kalam. However, the RBI and Indian authorities have consistently upheld Gandhi’s representation, considering him the most fitting embodiment of India’s ethos.

Conclusion

  • Gandhi’s Enduring Legacy: Mahatma Gandhi’s presence on Indian currency notes stands as a testament to his indelible impact on the nation’s history and values.
  • Challenges to Change: While various proposals have emerged over the years, the symbolism and significance of Gandhi on banknotes remain unwavering, reflective of his towering stature in India’s collective consciousness.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to discontinue Incremental Cash Reserve Ratio (I-CRR)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Incremental Cash Reserve Ratio (I-CRR)

Mains level: Not Much

Central Idea

  • The Reserve Bank of India (RBI) announced the phased discontinuation of the Incremental Cash Reserve Ratio (I-CRR) on September 8, 2023.
  • This measure aimed to absorb surplus liquidity created by factors such as the return of Rs 2,000 notes to the banking system.

RBI’s Decision

  • RBI conducted a review and decided to discontinue I-CRR in stages.
  • The central bank aims to release the impounded amounts gradually to avoid sudden shocks to the system’s liquidity, ensuring orderly money market functioning.

Understanding Cash Reserve Ratio (CRR)

  • CRR is a fundamental concept before delving into Incremental Cash Reserve Ratio (ICRR).
  • Banks are mandated to maintain a certain portion of their deposits and specific liabilities in liquid cash with the RBI.
  • CRR serves as a crucial tool in the RBI’s arsenal for managing liquidity in the economy and acts as a safety net during times of banking stress.
  • Currently, banks are required to uphold 4.5% of their Net Demand and Time Liabilities as CRR with the RBI.

Introduction to ICRR

  • I-CRR was introduced on August 10, 2023, as a temporary measure by RBI to absorb surplus liquidity.
  • Banks were required to maintain an I-CRR of 10% on the increase in their Net Demand and Time Liabilities (NDTL) between May 19, 2023, and July 28, 2023.
  • It came into effect from the fortnight starting August 12, 2023.
  • The RBI has the authority to implement an additional measure called Incremental Cash Reserve Ratio (ICRR), in addition to the standard CRR.
  • ICRR is employed during periods characterized by excess liquidity in the financial system.
  • Essentially, ICRR mandates that banks park even more liquid cash with the RBI than what is required under CRR.
  • This serves as a means to further manage and control liquidity in the banking system.

Reason for I-CRR

  • Excessive liquidity emerged due to factors like the return of Rs 2,000 banknotes, RBI’s surplus transfer to the government, increased government spending, and capital inflows.
  • The daily liquidity absorption by RBI in July reached Rs 1.8 lakh crore.
  • Managing surplus liquidity was necessary to maintain price and financial stability.

Impact on Liquidity Conditions

  • I-CRR was expected to absorb over Rs 1 lakh crore of excess liquidity from the banking system.
  • It temporarily shifted the banking system’s liquidity from surplus to deficit on August 21.
  • Factors like GST outflows and central bank selling of dollars contributed to tight liquidity.
  • However, liquidity conditions reverted to surplus from August 24.
  • On September 8, RBI absorbed Rs 76,047 crore of surplus liquidity from the system.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

UPI-CBDC Interoperability: Advancing Retail Digital Rupee Adoption

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CBDI, UPI

Mains level: Read the attached story

upi-cbdc

Central Idea

  • The convergence of Unified Payments Interface (UPI) Quick Response (QR) codes with Central Bank Digital Currency (CBDC) applications is set to revolutionize digital transactions in India.
  • This strategic integration enables users of the retail digital rupee to seamlessly transact using UPI QR codes, making transactions convenient for both customers and merchants.

Understanding Interoperability

  • Interoperability refers to the technical compatibility that allows different payment systems to function together.
  • It empowers various payment systems to process transactions across platforms, contributing to efficiency, innovation, and adoption for end-users.

UPI QR Code-CBDC Interoperability: Explained

The Reserve Bank of India (RBI) is driving this interoperability between UPI and CBDC as part of its ongoing pilot project for the retail digital rupee (e₹-R).

  • Initially, e₹-R users required a specific QR code for transactions.
  • With UPI-CBDC interoperability, any UPI QR code becomes compatible with CBDC apps.
  • The digital rupee, issued by RBI, is a tokenized digital version of the rupee stored in a digital wallet linked to a savings bank account.
  • UPI, directly linked to a user’s account, can now transact seamlessly with CBDC.

Benefits for Customers and Merchants

The convergence of UPI and CBDC yields several advantages:

  • Customers can use a single QR code for various transactions, eliminating the need for multiple platforms.
  • Daily essentials like groceries and medicines can be purchased using any UPI QR code.
  • Merchants can accept CBDC payments without creating separate QR codes.
  • Transactions are streamlined and efficient, enhancing the user experience.

Enhancing CBDC Adoption

The UPI-CBDC interoperability leverages the widespread use of UPI to boost digital rupee adoption.

  • More than 70 mobile apps and 50 million merchants already accept UPI payments.
  • Integrating UPI with CBDC simplifies transactions, increasing the digital rupee’s utility.
  • Prominent banks like State Bank of India, HDFC Bank, and Axis Bank have introduced UPI interoperability on their digital rupee platforms.
  • This seamless integration is expected to transform the digital currency landscape, driving its acceptance and utilization.

Conclusion

  • The UPI-CBDC interoperability marks a significant milestone in India’s digital payment ecosystem.
  • By merging the familiarity of UPI with the innovation of CBDC, the retail digital rupee becomes more accessible, user-friendly, and efficient.
  • This strategic integration is poised to accelerate the adoption of digital currencies, reshaping the way transactions are conducted in the country.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI unveils UDGAM portal for Unclaimed Deposits Claims

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Udgam Portal

Mains level: Read the attached story

 

udgam

Central Idea

  • The RBI has launched Centralised Web Portal called UDGAM to search and retrieve unclaimed deposits from various banks, all in one centralized location.

What are Unclaimed Deposits?

  • The RBI defines “Unclaimed Deposits” as funds residing in dormant savings or current accounts for a duration of ten years.
  • Similarly, for fixed deposits (FDs), the funds remain unclaimed if they have not been withdrawn within ten years from the maturity date.

 

About UDGAM Portal

  • The UDGAM portal is a centralized web platform launched by the Reserve Bank of India (RBI) called “Unclaimed Deposits – Gateway to Access inforMation.”
  • It is collaborated by Reserve Bank Information Technology Pvt Ltd (ReBIT), Indian Financial Technology & Allied Services (IFTAS), and participating banks.
  • It aims to provide individuals with an accessible and user-friendly platform to search and retrieve their unclaimed deposits from various banks in one centralized location.
  • The portal consolidates unclaimed deposit data from different banks.
  • It empowers users to identify their dormant accounts and take actions such as claiming the deposited amount or reactivating their dormant accounts directly through their respective banks.

Key Features

The UDGAM Portal brings forth a set of user-centric features that redefine the approach to reclaiming unclaimed deposits:

  • Reclaim or Activate: Through this platform, users have the autonomy to initiate either the process of reclaiming the deposited amount or reactivating their dormant accounts, all under the umbrella of their respective banks.
  • Effortless Registration: Customers can swiftly register on the UDGAM Portal using their mobile numbers, initiating their journey towards unlocking their unclaimed funds.
  • Search and Input: Once registered, users can seamlessly search for their unclaimed deposits by inputting essential details such as their name, PAN, voter ID, driving license, and passport number.
  • KYC Process: Upon locating their deposits, customers can facilitate their retrieval by completing a streamlined Know Your Customer (KYC) process through their respective bank branches.
  • Nominee Assistance: In instances where the deposit holder is no longer alive, the nominee can facilitate the retrieval process by providing the necessary documents.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Public Tech Platform for Frictionless Credit

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Features of the platform

Mains level: Not Much

Central Idea

  • The Reserve Bank of India (RBI) has unveiled a Public Tech Platform for Frictionless Credit to transform credit accessibility and lending efficiency.

About the Public Tech Platform 

  • It is developed by the RBI’s subsidiary Reserve Bank Innovation Hub (RBIH).
  • It aims to streamline the credit delivery process by enabling seamless digital information flow to lenders.
  • It intends to simplify the credit assessment by providing an end-to-end digital ecosystem that facilitates the smooth exchange of essential digital data among stakeholders.

Features of the Platform

  • Open Architecture: The platform adopts an open architecture model, fostering interoperability and collaboration among various financial sector players.
  • Plug and Play Model: The open Application Programming Interfaces (APIs) and standards enable seamless integration and interaction among participating entities.
  • Efficiency and Scalability: The platform aims to enhance lending efficiency, reduce costs, expedite disbursement, and scale up lending operations.

Launch and Scope

  • Calibrated Rollout: The platform is set to launch as a pilot project on August 17, 2023, with gradual access to information providers and use cases.
  • Initial Focus: The pilot phase will focus on credit products like Kisan Credit Card loans, dairy loans, collateral-free MSME loans, personal loans, and home loans.
  • Integration and Services: The platform will integrate services such as Aadhaar e-KYC, state government land records, satellite data, PAN validation, Aadhaar e-signing, account aggregation, and more.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Withdrawal of ₹2,000 Note: A Tragi-Comic Episode in Demonetisation Saga

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Demonetization

Mains level: withdrawal of the ₹2,000, the demonetization chapter, rationale and implications

₹2,000 Note

Central Idea

  • The withdrawal of the ₹2,000 note from circulation by the Reserve Bank of India (RBI) on May 19, 2023, marks the conclusion of a tumultuous chapter in the dramatic saga of demonetisation. The presence of this high-denomination note had been a constant reminder of the hardships faced by the people during the chaotic demonetisation period. The note’s withdrawal was long anticipated, given the government’s decision to cease its printing after 2018-19.

About the ₹2000 Notes

  • The ₹2000 denomination banknote was introduced in November 2016 under Section 24(1) of RBI Act, 1934.
  • It primarily aimed to meet the currency requirement of the economy in an expeditious manner after withdrawal of the legal tender status of all ₹500 and ₹1000 banknotes in circulation at that time.

Reasons for withdrawal

  • Demonetization purpose served: Printing of ₹2000 notes was stopped in 2018-19 as other denominations became available in adequate quantities.
  • Clean Note Policy: This aims to provide good-quality currency notes with enhanced security features and withdraw soiled notes from circulation.
  • Ending timespan: Majority of the ₹2000 notes were issued prior to March 2017 and have reached their estimated lifespan of 4-5 years.
  • Disappeared from circulation: This denomination is not commonly used for transactions, and there is sufficient stock of banknotes in other denominations to meet public requirements.

The mixed impact of the withdrawal of the ₹2,000 note

  • Reduced Circulation: As of March 31, 2023, the ₹2,000 note accounted for only 10.8% of all notes in circulation, down from 37.3% on March 31, 2018. This significant reduction indicates that the withdrawal of the ₹2,000 note will have a relatively small direct impact on the overall currency circulation in the country.
  • Remnant of Demonetisation: The ₹2,000 note was closely associated with the 2016 demonetisation policy, which aimed to combat black money and promote a digital economy. Its withdrawal marks the end of a chapter in the demonetisation saga and symbolically represents the closure of that particular phase of currency reform.
  • Economic Stability: The note had been associated with various challenges, including logistical issues, poor printing quality, and difficulties in conducting transactions due to the scarcity of smaller denomination notes. Removing the note from circulation could help streamline currency operations and enhance confidence in the currency system.
  • Public Perception: The ₹2,000 note had become a symbol of the hardships and inconveniences faced by the public during demonetisation, with long queues and limited availability of smaller denomination notes. Its withdrawal may generate mixed reactions among the public.
  • Future Monetary Policy: The withdrawal of the ₹2,000 note raises questions about the potential introduction of a new higher denomination note or alternative measures to address currency logistics and store of value concerns. It may prompt policymakers to reassess the currency composition and devise strategies to meet the evolving economic requirements

Errors occurred in relation to the ₹2,000 note during demonetization 

  • Insufficient Replacement Planning: The government failed to anticipate the need for an adequate supply of replacement notes when demonetisation was implemented. As a result, more ₹2,000 notes had to be printed to facilitate remonetisation, causing logistical challenges.
  • Recalibration Crisis: The introduction of the new ₹2,000 note, with its larger size, necessitated the recalibration of all ATMs in India. This massive and complex exercise required coordination across various entities, leading to disruptions and delays.
  • Shortage of Smaller Denomination Notes: In an ad hoc measure to address the shortage of ₹100 notes, banks filled ATMs with soiled and worn-out currency, which frequently jammed the machines and added to the chaos.
  • Poor Quality Printing: Many ₹2,000 notes were poorly printed, exhibiting defects such as shadows of Mahatma Gandhi’s face, uneven borders, and variations in color shades and sizes. This compromised the authenticity of the notes and made it easier for criminals to circulate counterfeit copies.
  • Difficulty in Transactions: Even when people managed to obtain a ₹2,000 note, they often faced difficulties in spending it. Businesses were reluctant to provide change or balance payments for transactions involving the high-denomination note, exacerbating the shortage of smaller denomination notes.

The need for a larger denomination note

  • Store of Value: In an economy with rising per capita incomes and inflation, the highest denomination note serves as a store of value. As the value of lower denomination notes erodes over time, a higher denomination note becomes necessary to preserve and facilitate transactions involving larger amounts of money.
  • Cash-to-GDP Ratio: The cash-to-GDP ratio in India has been increasing, indicating a higher circulation of cash in the economy. To accommodate this growing cash flow and maintain efficiency in currency logistics, the introduction of a larger denomination note may be warranted.
  • Inflation and Real Interest Rates: With rising inflation and falling real interest rates, a larger denomination note can help individuals and businesses better manage their financial transactions and store value without being adversely affected by the eroding value of smaller denomination notes.
  • Currency Management Challenges: The withdrawal of the ₹2,000 note raises questions about whether the ₹500 note, the next highest denomination, can effectively serve as a store of value. The increasing cash circulation, coupled with the challenges of managing currency logistics, may necessitate the introduction of a new higher denomination note
  • Stability and Credibility: Introducing a larger denomination note can help restore stability and confidence among individuals and businesses, providing them with a reliable store of value and a means to conduct transactions more efficiently.

Way Ahead

  • Introducing a New Higher Denomination Note: The introduction of a new note, such as ₹1,000, ₹5,000, or ₹10,000, could address the evolving cash-to-GDP ratio and ensure efficient currency logistics.
  • Assessing Currency Logistics: The increasing circulation of cash, rising inflation, and falling real interest rates necessitate careful evaluation of currency supply and demand. The RBI will need to consider whether the current denominations are sufficient or if additional higher denomination notes are required.
  • Evaluating Digital Currency Options: As technology advances, digital currencies, such as e-rupee, are being explored as potential alternatives to physical cash. However, the properties and infrastructure required for a digital currency to become a widely accepted store of value are still evolving. The RBI needs to assess the viability, stability, and acceptance of digital currencies before considering them as potential substitutes for higher denomination notes.
  • Ensuring Currency Stability: To restore stability and confidence, the RBI needs to adopt consistent policies and provide clarity on the future of higher denomination notes. Maintaining a stable currency is essential for economic growth and the confidence of individuals and businesses.
  • Adapting to Economic Dynamics: The evolving economic landscape, including factors like cash usage patterns, inflation, and real interest rates, should be closely monitored. Currency management strategies must align with the changing needs of the economy and the preferences of individuals and businesses

Conclusion

  • The withdrawal of the ₹2,000 note signifies the end of a troubled chapter in India’s demonetisation saga. As the economy progresses, the need for a larger denomination note or alternative solutions to address currency logistics and store of value concerns must be carefully considered to ensure the stability and credibility of India’s monetary system.

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Also read:

Evaluating the RBI’s Recent Currency withdrawal Decision

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Evaluating the RBI’s Recent Currency withdrawal Decision

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Demonetization, Basics over the role of central bank

Mains level: Demonetization, recent withdrawal of the ₹2,000 notes, rationale behind, impact and concerns

Currency

Central Idea

  • When discussing the value of a currency, the focus often revolves around its exchange rate and purchasing power. However, there is a more fundamental aspect to consider is the confidence citizens have in its acceptance and stability as a medium of exchange and store of value. This confidence is deeply rooted in the trust placed in the central bank, such as the Reserve Bank of India (RBI).

Rationale behind the decision to withdraw ₹2,000 notes from circulation while keeping them legal tender

  • Promoting Clean Note Policy: The withdrawal is part of the RBI’s initiative to promote a cleaner currency system. By encouraging the exchange of soiled or damaged notes, the RBI aims to improve the overall quality of currency in circulation.
  • Curbing Black Money: The decision is aimed at curbing the hoarding of black money, as higher denomination notes are often associated with illicit activities. By limiting the usage of ₹2,000 notes, the RBI intends to discourage the accumulation of unaccounted wealth.
  • Enhancing Transparency: The withdrawal is expected to increase transparency in financial transactions. By reducing the availability of high-value currency, the RBI aims to encourage a shift towards digital payments and traceable transactions.
  • Addressing Counterfeit Concerns: The withdrawal may help mitigate the risks associated with counterfeit currency. High-denomination notes are often targeted by counterfeiters, and by withdrawing ₹2,000 notes, the RBI aims to combat counterfeiting and maintain the integrity of the currency.
  • Managing Currency Supply: The withdrawal allows the RBI to better manage the supply and circulation of currency. By gradually replacing ₹2,000 notes with lower denomination currency, the RBI can ensure an adequate availability of notes for day-to-day transactions.
  • Aligning with Majority Usage: The decision is based on the observation that a significant majority of transactions in India involve lower monetary values. By withdrawing ₹2,000 notes, which are predominantly used for high-value transactions, the RBI aims to align the currency with the needs of the majority of the population.

Potential Impact of this move on Business and Economy

  • Uncertainty and Business Sentiment: The move to withdraw ₹2,000 notes may create uncertainty among businesses, as sudden changes in the currency system can disrupt economic activities. This uncertainty can affect business sentiment and decision-making, potentially leading to a cautious approach in investments and expansion plans.
  • Cash-dependent Sectors: Certain sectors that heavily rely on cash transactions, such as small businesses, informal sectors, and rural areas, may face challenges in adjusting to the withdrawal. The availability of lower denomination notes to replace ₹2,000 notes and the need for individuals to exchange their existing notes can temporarily disrupt cash flow in these sectors.
  • Digital Payment Adoption: With the reduction in the availability of high-value currency, there may be a push for increased adoption of digital payment methods. The withdrawal can potentially accelerate the ongoing shift towards digital transactions, as individuals and businesses seek alternatives to cash transactions.
  • Impact on Consumption: The withdrawal can have implications for consumer spending patterns. If individuals perceive a scarcity of high-value currency, it may affect their spending behavior, particularly for larger purchases. This could lead to a short-term dampening of consumer demand and impact certain sectors of the economy, such as real estate and luxury goods.
  • Counterfeit and Black Money: The withdrawal of ₹2,000 notes aims to combat counterfeiting and curb the hoarding of black money. If successful, it can contribute to enhancing the integrity of the currency and promoting a more transparent financial system. However, the actual impact on eliminating black money and counterfeit currency will depend on the effectiveness of enforcement measures and the adoption of alternative means for illicit transactions.
  • Financial Inclusion: The withdrawal may pose challenges for individuals who have limited access to banking services or digital payment infrastructure. Efforts will be needed to ensure that the transition does not hinder financial inclusion and that adequate support is provided to vulnerable segments of the population.

Concerns and arguments over the central bank’s reputation

  • Demonetization Fallout: The implementation of demonetization in 2016, where high-value currency notes were invalidated, received mixed reactions. Critics argue that the RBI’s involvement in the decision-making process and its execution raised questions about the central bank’s independence and its ability to manage the country’s monetary policies effectively.
  • Inflation Management: The RBI’s primary mandate is to maintain price stability and control inflation. However, the central bank has faced challenges in achieving its inflation targets consistently. Critics contend that the RBI’s monetary policy framework and communication strategies could be improved to ensure better alignment with its objectives and boost its reputation in inflation management.
  • Banking Sector Oversight: The RBI is responsible for overseeing the banking sector and maintaining financial stability. Some argue that the central bank could have been more proactive in detecting and addressing issues related to non-performing assets (NPAs) and the overall health of banks. The perceived delays in taking corrective measures and addressing governance issues have raised concerns about the effectiveness of the RBI’s regulatory oversight.
  • Communication and Transparency: The RBI’s communication and transparency have been points of discussion. Critics argue that the central bank could enhance its communication strategies, ensuring clearer and more consistent messaging about policy decisions and their objectives.
  • Autonomy and Independence: The reputation of the RBI rests heavily on its autonomy and independence from external influences. Concerns have been raised over potential encroachments on the central bank’s independence, such as the invocation of certain provisions of the RBI Act and debates around the RBI’s relationship with the government. Preserving the RBI’s autonomy is seen as crucial for maintaining its reputation as a credible and independent institution.

What measures RBI must take to restore and maintain its reputation?

  • Transparency and Communication: The RBI should prioritize transparency in its operations and decision-making process. It should provide clear and timely communication regarding policy decisions, objectives, and the rationale behind its actions. Regular and effective communication can help build public trust and enhance understanding of the RBI’s role in maintaining a stable and resilient financial system.
  • Independence and Autonomy: The RBI should emphasize its independence from political interference. It should ensure that its decision-making process remains free from external pressures and is based on sound economic principles. Upholding its autonomy strengthens the perception of the RBI as a credible and reliable institution.
  • Consistency and Predictability: A clear and consistent approach to monetary policy, regulation, and supervision fosters stability and confidence in the financial system. Avoiding abrupt shifts or reversals in policy direction can enhance the RBI’s reputation for sound decision-making.
  • Accountability and Oversight: The RBI should establish robust mechanisms for accountability and oversight. This includes effective internal controls, external audits, and appropriate checks and balances to ensure that the RBI’s policies and actions align with its mandate and serve the best interests of the economy. Accountability helps maintain public confidence in the RBI’s operations.
  • Economic Stability and Financial Inclusion: The RBI should prioritize its mandate of maintaining economic stability while promoting financial inclusion. By implementing effective monetary policies, managing inflation, and ensuring a resilient financial system, the RBI can contribute to sustainable economic growth and reduce income disparities.
  • Continuous Learning and Adaptation: The RBI should emphasize continuous learning, research, and adaptation to evolving economic and financial challenges. Staying informed about global best practices, monitoring emerging risks, and proactively addressing new challenges will enable the RBI to enhance its effectiveness and reputation as a forward-looking institution.

Conclusion

  • The recent actions of the Reserve Bank of India (RBI), including the withdrawal of the ₹2,000 note and the aftermath of the 2016 demonetization, have cast doubt on the RBI’s judgment and ability to uphold public trust. By aligning its actions with the long-term interests of the Indian economy, the RBI can preserve the value of the currency and ensure stability in the financial system. Only then can the RBI regain its reputation and fulfill its role as a trustworthy and effective central bank

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Also read:

RBI to pull out ₹2000 notes from active circulation

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI Surplus Transfer to Govt.

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RBI's Income

Mains level: RBI revenue sharing with govt

surplus rbi

Central Idea

  • The Central Board of Directors of the RBI approved the transfer of ₹87,416 crore as surplus to the Union government for the accounting year 2022-23.
  • This amount is almost three times the ₹30,307 crore transferred in the previous fiscal year.

Reserve funds of RBI

The RBI has two types of reserves: Currency & Gold Revaluation Account (CGRA) and Contingency Fund (CF).

  1. CGRA: It represents the value of gold and foreign currency held by the RBI on behalf of India and fluctuates based on market movements.
  2. Contingency Fund: It is a provision to meet unexpected contingencies arising from the RBI’s monetary policy and exchange rate operations.

Calculation of Surplus

  • RBI’s surplus is the amount transferred to the government after meeting its needs and provisions.
  • The surplus is determined by deducting expenses, including provisions made to the CF, from the RBI’s income, mainly generated through interest on securities.

How does RBI earn its INCOME?

The RBI earns profits through various functions and operations it carries out, including:

  1. Managing the borrowings of the Government of India and State governments.
  2. Supervising and regulating banks and non-banking finance companies.
  3. Managing the currency and payment systems.

RBI generates income through the following sources:

  1. Returns on its foreign currency assets, such as bonds and treasury bills of other central banks or top-rated securities.
  2. Interest earned on holdings of local rupee-denominated government bonds or securities.
  3. Interest earned from lending to banks for short tenures, such as overnight loans.
  4. Management commission received for handling government and state government borrowings.

Expenditure by RBI

The RBI’s expenditures include-

  1. Costs related to printing currency notes
  2. Staff salaries
  3. Commissions paid to banks for government transactions and
  4. Payments to primary dealers for underwriting borrowings

How the transfer of surplus takes place?

  • The RBI, as a central bank, is not a commercial organization owned or controlled by the government.
  • The RBI was initially a private shareholders’ bank but was nationalized by the government in January 1949.
  • According to Section 47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934, the RBI transfers the excess of income over expenditure to the government.
  • This provision mandates the transfer of profits to the Central Government after accounting for necessary provisions and obligations.

Does the RBI pay tax on these earnings or profits?

  • No, the RBI is exempted from paying income tax or any other tax as per Section 48 (Exemption of Bank from income-tax and super-tax) of the RBI Act, 1934.
  • This exemption ensures that the RBI is not liable to pay income tax or super-tax on its income, profits, or gains.

Policy inputs

(1) Y H Malegam Committee

  • It reviewed the adequacy of reserves and surplus distribution policy in 2013, recommended a higher transfer to the government.
  • Prior to this recommendation, the RBI transferred a portion of the surplus to the Contingency Fund and the Asset Development Fund.
  • Following the Malegam committee’s recommendation, the percentage of surplus transferred to the government significantly increased from 53.40% in 2012-13 to 99.99% in 2013-14.

(2) Bimal Jalan Committee

  • The RBI in November 2018 had constituted a 6-member committee, chaired by former governor Dr Bimal Jalan.
  • It was tasked to review the current economic capital framework (ECF), after the Ministry of Finance asked the central bank to follow global practices.

Key recommendations

  1. Differentiate between realised equity and revaluation balances for RBI’s economic capital.
  2. Adopt Expected Shortfall (ES) for measuring market risk with a target of ES 99.5% confidence level.
  3. Maintain Contingent Risk Buffer (CRB) between 6.5% and 5.5% of RBI’s balance sheet.
  4. Implement surplus distribution policy based on realised equity.
  5. Review RBI’s Economic Capital Framework every five years.

 

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to pull out ₹2000 notes from active circulation

Note4Students

From UPSC perspective, the following things are important :

Prelims level: NA

Mains level: RBI regulation of Currency

2000

Central Idea

  • The Reserve Bank of India (RBI) has decided to withdraw ₹2000 denomination banknotes from circulation as part of its “Clean Note Policy.”
  • The withdrawal is similar to a previous withdrawal of notes in 2013-2014 (and not the demonetization).

Legal Tender Status of ₹2,000 Banknotes

  • ₹2000 banknotes will continue to maintain their legal tender status.
  • People can use ₹2000 banknotes for transactions and accept them as payment.
  • However, the RBI encourages depositing or exchanging the notes by September 30, 2023.

About the ₹2000 Notes

  • The ₹2000 denomination banknote was introduced in November 2016 under Section 24(1) of RBI Act, 1934.
  • It primarily aimed to meet the currency requirement of the economy in an expeditious manner after withdrawal of the legal tender status of all ₹500 and ₹1000 banknotes in circulation at that time.

Reasons for withdrawal

  • Demonetization purpose served: Printing of ₹2000 notes was stopped in 2018-19 as other denominations became available in adequate quantities.
  • Clean Note Policy: This aims to provide good-quality currency notes with enhanced security features and withdraw soiled notes from circulation.
  • Ending timespan: Majority of the ₹2000 notes were issued prior to March 2017 and have reached their estimated lifespan of 4-5 years.
  • Disappeared from circulation: This denomination is not commonly used for transactions, and there is sufficient stock of banknotes in other denominations to meet public requirements.

Withdrawal process

  • People can deposit ₹2,000 notes into their bank accounts or exchange them for banknotes of other denominations at any bank branch.
  • The usual deposit process without restrictions and subject to applicable statutory provisions applies.
  • Banks have been directed to provide deposit and exchange facilities for ₹2,000 notes until September 30, 2023.
  • The facility for exchange up to ₹20,000 at a time will be available at banks and RBI’s Regional Offices from May 23, 2023.
  • Banks are instructed to stop issuing ₹2,000 notes immediately.

Impact and financial analysis

  • Deposit accretion of banks may improve in the short term, similar to the demonetization period.
  • Improved deposit rates may reduce pressure on interest rate hikes and lead to moderation in short-term interest rates.

Clean Note Policy

Previously, banknotes issued before 2005 were withdrawn due to fewer security features.

Notes issued before 2005 are still legal tender but no longer in circulation to maintain consistency with international practices.

Key issues

  • Individuals can seek multiple exchanges in packets of ₹20,000, but this may attract attention from enforcement agencies and the Income-tax Department.
  • Large sums of money in ₹2,000 notes may be difficult to exchange.
  • It is likely to witness chaos and long queues in bank branches.

FAQs: Exchanging and depositing ₹2,000 Banknotes

  • Individuals should approach bank branches for depositing or exchanging ₹2,000 banknotes.
  • Deposit and exchange facilities will be available at banks until September 30, 2023.
  • Exchange facilities will also be available at 19 RBI Regional Offices.
  • There is a limit of ₹20,000 for each exchange transaction.
  • Account holders can exchange up to ₹4,000 per day through business correspondents.
  • Deposits into bank accounts have no restrictions, but compliance with KYC norms and other regulatory requirements is necessary.
  • From May 23, 2023, people can approach bank branches or RBI Regional Offices to exchange their ₹2,000 notes.

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI regulations on Green Deposits

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Green Deposits

Mains level: Not Much

Central Idea: The Reserve Bank of India (RBI) has introduced a regulatory framework to govern the acceptance of green deposits by banks, ensuring transparency and accountability in their investments.

What are Green Deposits?

  • Green deposits are financial products offered by banks that are similar to regular deposits, but the money received is specifically earmarked for environmentally friendly projects.
  • These deposits support projects aimed at combating climate change, such as renewable energy initiatives, while avoiding investments in activities that harm the environment, like fossil fuel projects.
  • They are part of a broader range of financial products, including green bonds and green shares that enable investors to contribute to environmentally sustainable projects.

Regulatory framework for accepting Green Deposits

  • The RBI’s framework mandates that banks establish a set of rules or policies, approved by their respective Boards, to guide the investment of green deposits.
  • These rules must be made public on the banks’ websites, ensuring transparency and enabling customers to make informed decisions.
  • Banks are required to disclose information on the amount of green deposits received, how these funds are allocated to different green projects, and the environmental impact of such investments.
  • To verify the banks’ claims and the sustainability credentials of the projects, a third-party is appointed to conduct independent verification.

Sectors eligible for green deposits

  • The RBI has identified a list of sectors classified as sustainable, which are eligible to receive green deposits.
  • These sectors include renewable energy, waste management, clean transportation, energy efficiency, and afforestation.
  • Banks are prohibited from investing green deposits in sectors considered detrimental to the environment, such as fossil fuels, nuclear power, tobacco, gambling, palm oil, and hydropower generation.

Addressing greenwashing

  • Greenwashing refers to the practice of making misleading claims about the positive environmental impact of an activity or investment.
  • The RBI’s regulatory framework aims to prevent greenwashing in the banking sector by ensuring that the actual impact of green deposits is accurately represented.
  • By requiring transparency, disclosure, and third-party verification, the framework aims to protect customers from deceptive practices and ensure genuine environmental benefits.

Impact and controversies

  • Depositors who prioritize environmental concerns may find satisfaction in investing their money in environmentally sustainable products like green deposits.
  • However, some critics argue that green investment products may primarily serve to make investors feel good without generating significant environmental benefits.
  • Additionally, the range of projects available for investment through green deposits may be limited, posing challenges in achieving broad environmental impact.

Key challenge: Assessing environmental sustainability

  • Evaluating the true environmental sustainability of a project can be challenging in a complex world with interconnected systems and second-order effects that are difficult to anticipate.
  • It is essential to consider the indirect consequences and long-term effects of actions to determine if a project genuinely contributes to environmental sustainability.
  • Uncertainty surrounding the actual environmental impact of green projects highlights the need for rigorous evaluation and ongoing monitoring to ensure the desired outcomes are achieved.

 

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to join Greenwashing TechSprint

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Greenwashing, Global Financial Innovation Network (GFIN)

Mains level: Read the attached story

Central Idea: The RBI has announced its participation in the Global Financial Innovation Network’s (GFIN) Greenwashing TechSprint.

What is Greenwashing?

  • Greenwashing is a term used to describe the practice of making exaggerated, misleading, or unsubstantiated claims about the environmental, social, and governance (ESG) credentials of a product, service, or company.
  • It is a deceptive marketing strategy that aims to portray an organization as environmentally friendly or socially responsible, even when its actions or practices do not align with these claims.
  • It creates the perception that a company is taking steps towards sustainability or social responsibility, but in reality, it may be engaging in practices that are harmful to the environment or society.

There are various forms of greenwashing that companies may employ to deceive consumers or investors. These include:

  1. Vague or ambiguous claims: Companies may use general statements or buzzwords without providing specific details or evidence to support their environmental or social claims. For example, stating that a product is “eco-friendly” without explaining the specific environmental benefits or certifications.
  2. Irrelevant or misleading labels: Companies may use misleading labels or certifications that give the impression of sustainability or social responsibility but lack meaningful standards or independent verification. This can confuse consumers who rely on such labels to make informed choices.
  3. Hidden trade-offs: Greenwashing can involve emphasizing one positive aspect of a product or company’s operations while ignoring or downplaying other negative impacts. For instance, a company may highlight its use of renewable energy while disregarding other harmful environmental practices.
  4. Lack of transparency: Companies may fail to provide transparent information about their sustainability practices or refuse to disclose relevant data. This lack of transparency makes it difficult for consumers to verify the accuracy of the company’s claims.
  5. Inconsistent messaging: Some companies may adopt green initiatives or promote sustainable products as a public relations exercise, without making substantial changes to their overall operations. This inconsistency between their messaging and actual practices is a form of greenwashing.

Implications of greenwashing

  • It undermines consumer trust, as people may make purchasing decisions based on misleading information.
  • It also hampers the credibility of genuinely sustainable businesses by creating scepticism in the market.
  • Moreover, it can divert attention and resources away from genuinely sustainable companies and initiatives.

Back2Basics: Global Financial Innovation Network (GFIN)

  • GFIN was officially launched in January 2019.
  • It was inspired by the successful collaboration between 11 financial regulators during a cross-border pilot project known as the “Global Sandbox” in 2018.
  • The pilot project demonstrated the benefits of regulatory cooperation and information sharing in fostering responsible innovation in the financial sector.
  • GFIN consists of financial regulators and related organizations from around the world.
  • The network includes regulatory authorities, central banks, and supervisory bodies.

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s gold reserves rise to 794.64 tonne

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Gold Reserves

Mains level: India's forex reserves and its implications

Central Idea: The RBI has increased its gold reserves by 34.22 tonnes YoY to reach 794.64 tonnes at the end of March 2023, according to the central bank’s data.

What are Gold Reserves?

  • Gold reserves refer to the physical gold holdings that a central bank or a country holds as a part of its foreign exchange reserves.
  • Central banks may acquire gold reserves through various means, including purchases from other central banks, international organizations, or commercial banks, and from domestic production or importation.
  • Gold reserves are typically held in the form of gold bars, which are stored in secure vaults or depositories.

Why Gold?

  • Gold is considered a safe-haven asset and has been historically used to back a country’s currency.
  • Holding gold reserves is seen as a way to hedge against inflation, currency fluctuations, and other economic uncertainties.

Significance of Gold Reserves

  • Economic stability: Gold reserves are often seen as a symbol of economic stability and confidence, especially during times of financial crisis or uncertainty. Holding gold reserves can help central banks to maintain the stability of their currency and the economy.
  • Diversification: Gold is considered a safe-haven asset and can provide diversification to a country’s foreign exchange reserves portfolio. Diversification helps to reduce the risks associated with any single asset class.
  • Hedge against inflation: Gold is considered an inflation hedge as its value tends to increase during times of high inflation or when the value of a currency is depreciating. Holding gold reserves can help to protect the purchasing power of a country’s currency.
  • International transactions: Gold reserves can be used as collateral for loans and international transactions. Countries can also use gold reserves to settle international debts.
  • Confidence-building: The level of a country’s gold reserves can be an indicator of the country’s financial strength and stability. High levels of gold reserves can help to build confidence among investors and other countries.

Breakdown of RBI’s gold reserves

  • Total: As of March-end 2023, the RBI held 794.64 metric tonnes of gold, including gold deposits of 56.32 metric tonnes.
  • Domestic and abroad: Out of the total gold reserves, 437.22 metric tonnes of gold is held overseas in safe custody with the Bank of England and the Bank of International Settlements (BIS), while 301.10 metric tonnes of gold is held domestically.

How much do these gold reserves value?

  • In value terms (USD), the share of gold in the total foreign exchange reserves increased from about 7.06% as of September-end 2022 to about 7.81% as of March-end 2023, as per the RBI’s report.
  • During the half-year period, the reserves increased from $532.66 billion as of September-end 2022 to $578.45 billion as of March-end 2023.

 

New terminologies

Foreign currency assets (FCA): a component of forex reserves that includes major traded currencies held by the central bank of a country.

Special drawing rights (SDRs): an international reserve asset created by the International Monetary Fund (IMF) to supplement member countries’ official reserves.

Reserve tranche position: a component of IMF’s financial accounts that represents a country’s reserve position in the organization.



Back2Basics: Foreign Exchange (Forex) Reserve

  • Foreign exchange reserves are important assets held by the central bank in foreign currencies as reserves.
  • They are commonly used to support the exchange rate and set monetary policy.
  • In India’s case, foreign reserves include Gold, Dollars, and the IMF’s quota for Special Drawing Rights.
  • Most of the reserves are usually held in US dollars, given the currency’s importance in the international financial and trading system.
  • Some central banks keep reserves in Euros, British pounds, Japanese yen, or Chinese yuan, in addition to their US dollar reserves.

India’s forex reserves cover:

  1. Foreign Currency Assets (FCAs)
  2. Special Drawing Rights (SDRs)
  3. Gold Reserves
  4. Reserve position with the International Monetary Fund (IMF)

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

CBDC for efficient Cross-Border Payment

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Central Bank Digital Currency (CBDC)

Mains level: CBDC used for foreign payments

cbdc

Central Idea: RBI Deputy Governor T. Rabi Shankar commented on CBDC platforms and their potential impact on cross-border payments during the G20 TechSprint.

About Central Bank Digital Currency (CBDC)

  • CBDC is a central bank-issued digital currency which is backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.
  • The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
  • Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.

Hurdles in Cross-Border Payments

  • Fragmented and truncated data formats: Lack of standardization in data formats creates inefficiencies in cross-border payments. Fragmented and truncated data formats create additional costs and delays in the processing of transactions.
  • Complex processing of compliance checks: Cross-border payments require compliance with different regulatory frameworks in different jurisdictions. Compliance checks can be complex and time-consuming, causing delays and additional costs.
  • Limited operating hours: Traditional banking systems have limited operating hours, which can cause delays in cross-border payments. International time zone differences also contribute to these challenges.
  • Legacy technology platforms: Traditional banking systems still rely on legacy technology platforms, which can be slow and outdated. This can lead to inefficiencies and delays in cross-border payments.
  • Long transaction chains: Cross-border payments often involve multiple intermediaries, which can lead to long transaction chains. Each intermediary adds additional costs and can increase the time it takes for a transaction to be completed.
  • Funding costs: Cross-border payments require funding in multiple currencies, which can lead to additional costs. Exchange rate fluctuations can also impact the cost of cross-border payments.
  • Weak competition: The lack of competition in the cross-border payments industry can contribute to inefficiencies and high costs. The dominance of a few large players can limit innovation and hinder the development of more efficient solutions.

Potential benefits with CBDC

  • Less intermediaries: CBDC can reduce the need for multiple intermediaries in cross-border payments, leading to a faster and more efficient process.
  • Enhanced efficiency: It can increase the speed and efficiency of cross-border payments by reducing processing times and delays.
  • Enhanced integration: It can enable better integration between different payment systems, reducing fragmentation and increasing interoperability.
  • Enhanced technical compatibility: It can be designed to work with existing payment infrastructure, making it easier to adopt and integrate into the current system.
  • Enhanced safety: It can provide enhanced security measures that can help mitigate the risk of fraud and cyber-attacks in cross-border payments.
  • Mitigation of cross-currency risks: CBDC can help mitigate risks associated with cross-border and cross-currency transactions, such as exchange rate fluctuations, currency conversion fees, and transaction processing delays.

How can this be implemented to practice?

 

Description Examples
Model 1 Enhancing Compatibility Among Domestic CBDC Systems Many central banks are working to enhance the compatibility of domestic CBDC systems. Common international standards are required, which require regulatory coordination and market practices.
Model 2 Interlinking CBDC Systems CBDC networks are linked up by synchronizing payment actions without the need for a trusted third party or a common platform.
Model 3 Establishing a Single mCBDC System Cross-border payments are processed through a jointly operated “corridor network”.

 

RBI’s push for CBDC adoption @ G20

  • RBI emphasized the need for increased adoption of CBDCs across countries for them to play a role in the cross-border payments arena.
  • Countries need to decide to create CBDCs and create an infrastructure for various CBDCs to interface for CBDCs to be effective in cross-border payments.
  • RBI suggested India’s model of digitization, where the basic infrastructure was created by the public sector and the fintech/financial/start-up ecosystem was allowed to create innovative solutions, could also be successful with CBDCs globally

Conclusion

  • CBDCs could bring about a significant change in the sphere of cross-border payments, but coordination across countries and between the public and private sectors is essential for that to happen

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get the Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is the Consumer Confidence Index (CCI)?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Consumer Confidence Index (CCI)

Mains level: Not Much

confidence

Central idea

  • The Consumer Confidence Survey was conducted in the first half of March 2023 across 19 cities.
  • This article analyses the survey results, released this month, and breaks down the findings under different sections.

What is Consumer Confidence Survey?

  • The Reserve Bank of India (RBI) conducts a Consumer Confidence Survey to measure consumers’ perceptions of the prevailing economic situation.
  • The survey is conducted across various cities and measures consumer confidence on parameters such as the economy, employment, price, income, and spending.
  • The survey consists of questions regarding consumers’ sentiments over various factors in the current situation and future.

Here are a few parameters that help aggregate overall confidence:

  1. Spending: The consumer is asked about the willingness to spend on major consumer durables, purchasing vehicles, or real estate. This measures the overall spending scenario on necessities as well as luxuries for the next quarter.
  2. Employment: The consumer is asked about current and future ideas on employment situations, joblessness, job security, which reflects the sentiments of the current or expected employment in the country.
  3. Inflation: The consumer is asked about interest rates and levels of prices of all goods, tracking the price expected by consumers and their spending on basic necessities.

About the Consumer Confidence Index (CCI)

  • CCI is a survey that is conducted every two months to measure how optimistic or pessimistic the consumers are regarding their financial situation.
  • The index measures the change in consumer perception on the financial situation in the last year and the future expectations index measures what the consumer thinks about his financial situation in the coming one year.
  • The main variables of the survey are: Economic situation, Employment, Price Level, Income and Spending.

Current perceptions of the survey

  • The survey estimates current perceptions and a year-ahead expectations on the economy, employment, price, income, and spending.
  • The results show that consumer confidence continues to recover from its historic low of mid-2021, but still remains pessimistic at 87.0, a 2.2 point increase from previous results.
  • The assessment of inflation conditions improved for the current period reflecting a higher confidence in prevailing economic conditions.
  • With regards to spending, sentiments were positive with signs of improvement compared to the last round conducted in January 2023.

What does this imply?

  • The survey shows that while consumer confidence is slowly recovering, it still remains pessimistic.
  • The survey results indicate positive sentiments on employment and spending, but a marginal dip in the country’s future economic situation.
  • Credit growth numbers indicate a rise in consumer spending.
  • The upcoming state and general elections could have an impact on the economy, and it remains to be seen how it will play out.

 

Get an IAS/IPS ranker as your personal mentor for UPSC 2024 | Schedule your FREE session and get Prelims prep Toolkit!

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

In news: Liberalised Remittance Scheme (LRS)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Liberalised Remittance Scheme (LRS)

Mains level: Not Much

Central idea: The Reserve Bank of India (RBI) is being asked to monitor card spend under the Liberalised Remittance Scheme (LRS).

Liberalised Remittance Scheme (LRS)

  • LRS is a facility provided by the Reserve Bank of India (RBI) to resident individuals to remit funds abroad for permitted current or capital account transactions or a combination of both.
  • The scheme was introduced in 2004 and has been periodically reviewed and revised by the RBI.
  • Under the scheme, resident individuals can remit up to a certain amount in a financial year for permissible transactions including education, travel, medical treatment, gifts, and investments in equity and debt securities, among others.
  • The limit for LRS is currently set at USD 250,000 per financial year.

Eligibility for LRS

  • LRS is open to everyone including non-residents, NRIs, persons of Indian origin (PIOs), foreign citizens with PIO status and foreign nationals of Indian origin.
  • The Scheme is NOT available to corporations, partnership firms, Hindu Undivided Family (HUF), Trusts etc.

Benefits provided by LRS

  • LRS is an easy process that anyone can use to transfer money between two countries.
  • It’s especially useful for businesses because they can use it to transfer funds to India, and investors can receive their investments back home.
  • LRS also has some added benefits, like fast transfer timing and no issues with exchange rates.

 


 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s new pilot project on Coin Vending Machines

Note4Students

From UPSC perspective, the following things are important :

Prelims level: QR coin vending

Mains level: Not Much

coin

The RBI in collaboration with banks is set to launch a pilot project to assess the functioning of a QR-code-based coin vending machine.

Coin Vending Machines

  • The vending machines would dispense coins with the requisite amount being debited from the customer’s account using United Payments Interface (UPI) instead of physical tendering of banknotes.
  • Customers would be endowed the option of withdrawing coins in required quantities and denominations.
  • The central idea here is to ease the accessibility to coins.
  • With particular focus on ease and accessibility, the machines are intended to be installed at public places such as railway stations, shopping malls and marketplaces.

Why such a move?

  • Prevent hoarding of coins: The situation with respect to coins is peculiar with the supply being very high. It is taking up a lot of storage space and is not getting properly distributed despite high demands.
  • Eliminate the physical tendering of banknotes: It was observed that the currency being fed into the machines (for coin exchange) were often found to be fake and could not be checked right at that point of time.

Do you know?

For perspective, coins in India are issued in denominations of 50 paise, one rupee, two rupees, five rupees, ten rupees and twenty rupees (not considering special edition coins of various denomination).

Coins of up to 50 paise are called ‘small coins’ while those of one rupee and above are called ‘rupee coins’.

 

How coins are significant in our economy?

  • As per the latest RBI bulletin, the total value of circulation of rupee coins stood at ₹28,857 crore as of December 30 last year. The figure is an increase of 7.2% from the year-ago period.
  • Circulation of small coins remained unchanged at ₹743 crore.
  • The figures above could be compared to the volume of digital payments until December 2022 which stood at approximately ₹9,557.4 crore, as per the Digidhan Dashboard.
  • The number is inclusive of mobile banking, internet banking, IMPS, BHIM-UPI and NEFT, among others.
  • Hence the reliance on UPI for dispensing coins is particularly noteworthy.

Is it going against the digital push?

  • RBI is in the midst of a pilot for the Central Bank Digital Currency (CBDC).
  • But this proposal should not be viewed as a “zero-sum game of digital versus cash.”
  • The two can easily supplement each other by re-circulating existing coins in the economy.

 

Attempt UPSC 2024 Smash Scholarship Test | FLAT* 100% OFF on UPSC Foundation & Mentorship programs

Get your Rs 10,000 worth of UPSC Strategic Package for FREE | PDFs, Zoom session, Tests, & Mentorship

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Latest spike in Inflation and RBI’s efforts

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Inflation and concepts

Mains level: latest spike in inflation, contributing factors and RBI's measures

RBI

Central Idea

  • India’s post-pandemic economic recovery has hit a roadblock with the resurgence of inflation, hindering progress despite three consecutive months of softening. Recent significant spike in inflation, leading the Reserve Bank of India to adopt an inflation-targeting stance by raising interest rates. However, the battle to curb inflation is still ongoing, and the latest data raises doubts about whether the RBI’s efforts are sufficient.

RBI

What is Inflation?

  • Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices.
  • Typically, prices rise over time, but prices can also fall (a situation called deflation).

Consumer Price Index (CPI)

  • CPI is used to monitor changes in the cost of living over time.
  • When the CPI rises, the average Indian family has to spend more on goods and services to maintain the same standard of living.
  • The economic term used to define such a rising prices of goods and services is Inflation.

RBI

Inflation outlook

  • RBI’s Inflation target: The inflation targeting framework mandates the RBI to achieve a CPI consumer price index inflation target of 4 per cent.
  • Inflation during the pandemic was still within the target band: During the pandemic period of March 2020 to September 2021, CPI inflation averaged 5.9 per cent. This was higher than the point target of 4 per cent but still within the inflation targeting band of 2-6 per cent.
  • Inflation outlook has been worsening: In 2022, CPI inflation was above the upper threshold of the RBI’s targeting band for 10 consecutive months, which meant the target was not achieved for three quarters in a row.
  • Optimism that the Inflation began softening: By December 2022, CPI inflation was down to 5.7 per cent. This led many to believe that the inflation peak had passed, and that inflation was on its way to the official target.
  • This optimism was misplaced: Underlying inflationary pressures still persist. The softening of inflation in November and December 2022 was largely driven by a steep fall in vegetable prices. Excluding vegetables, CPI inflation was in fact more than 7 per cent.
  • The misplaced optimism has now become evident: The January 2023 CPI inflation came out to be 6.5 per cent, once again crossing the upper threshold of the RBI’s inflation targeting band.

Back to basics: Core Inflation

  • The core inflation rate measures rising prices in everything except food and energy.
  • That’s because gas prices tend to escalate now and then. Higher gas costs increase the price of food and anything else that has large transportation costs.

inflation

What contributed to the latest spike in inflation?

  • Rise in food prices: With food accounting for 46 per cent of the overall CPI basket, a rise in food inflation from roughly 4 per cent in December 2022 to almost 6 per cent in January 2023 has played an important role in overall inflation going up.
  • Cereal inflation is soaring high: Within food, one component that has proved rather stubborn is cereal inflation. Between May and December 2022, year-on-year cereal inflation nearly doubled from 5 per cent to 14 per cent. In January 2023, this increased to 16 per cent. Within cereals, inflation in wheat has been steadily going up. Between May and December 2022, wheat inflation increased from 9 per cent to 22 per cent. It increased even further to 25 per cent in January 2023.
  • The steep rise in wheat prices reflects shortages: Data from the Food Corporation of India shows that stocks in government warehouses declined. The government has recently approved a release of three million tonnes in the open market. However, this is insufficient to restore market supplies.
  • Persistently high core inflation: Second, core (non-food, non-fuel) inflation in January came out to be 6.2 percent. This is consistent with the unyielding core inflation of 6 per cent for nearly three years now. A persistently high core inflation implies that price pressures have become entrenched in the system.
  • External factors also play a role: Inflation in developed countries continues to be high (6.4 per cent in the US; 8.5 per cent in the EU; 10.5 per cent in the UK). India is importing some of this elevated inflation through international trade in goods and services. Moreover, with China gradually opening up its economy after nearly three years of zero-Covid restrictions, commodity prices are likely to go up, which could exert renewed pressures on India’s inflation.

What have the policymakers been doing to address the inflationary concerns?

  • The government has done its bit by announcing a conservative Union budget for 2023-24: It has accorded primacy to much needed fiscal consolidation, and has refrained from announcing populist measures that could have arguably fuelled demand, and hence inflation.
  • The RBI has been doing its job as well: It increased the policy repo rate from a pandemic low of 4 per cent to 6.5 per cent in a span of 10 months. Unlike last year, when despite rising inflation, the monetary policy statements did not contain any forward guidance, the RBI, in its February 2023 statement, emphasised the importance to remain alert on inflation, thereby hinting that the monetary tightening cycle is not over yet.

Conclusion

  • Inflation has been a challenge for India’s economy post-pandemic, despite the RBI’s attempt to control it by raising interest rates. A credible glide path to bring inflation down is essential today.

Mains question

Q. Despite of RBI’s efforts there is significant spike in inflation In India. Discuss the factors that contributed to the latest spike in inflation in India and what are the policymakers doing to address inflationary concerns?

(Click) FREE 1-to-1 on-call Mentorship by IAS-IPS officers | Discuss doubts, strategy, sources, and more

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI announces pilot for QR code-based Coin Vending Machine

Note4Students

From UPSC perspective, the following things are important :

Prelims level: QR coin vending

Mains level: Not Much

qr

To improve the distribution of coins among members of the public, the Reserve Bank of India (RBI) is preparing a pilot project on QR code-based Coin Vending Machine (QCVM) in collaboration with a few leading banks.

QR code-based Coin Vending Machine (QCVM)

  • The QCVM is a cashless coin dispensation machine which would dispense coins against a debit to the customer’s bank account using Unified Payments Interface (UPI).
  • Unlike cash-based traditional Coin Vending Machine, the QCVM would eliminate the need for physical tendering of banknotes and their authentication.
  • Customers will also have the option to withdraw coins in the required quantity and denominations in QCVMs.

When will it be launched?

  • The pilot project is planned to be initially rolled out at 19 locations in 12 cities across the country.
  • Machines will be installed at public places such as railway stations, shopping malls, marketplaces to enhance ease and accessibility.
  • Based on the learnings from the pilot tests, guidelines would be issued to banks to promote better distribution of coins using QCVMs.

 

Crack Prelims 2023! Talk to our Rankers

(Click) FREE 1-to-1 on-call Mentorship by IAS-IPS officers | Discuss doubts, strategy, sources, and more

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI proposes Expected Loss-based Approach for Loan Provisioning

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Expected Loss-based Approach

Mains level: Debt management

The Reserve Bank of India (RBI) has proposed a framework for the adoption of an expected loss-based approach for loan provisioning by banks.

What is Loan-Loss Provision?

  • The RBI defines a loan loss provision as an expense that banks set aside for defaulted loans.
  • Banks set aside a portion of the expected loan repayments from all loans in their portfolio to cover the losses either completely or partially.
  • In the event of a loss, instead of taking a loss in its cash flows, the bank can use its loan loss reserves to cover the loss.
  • Since the bank does not expect all loans to become impaired, there is usually enough in the loan loss reserves to cover the full loss for any one or a small number of loans when needed.
  • An increase in the balance of reserves is called loan loss provision.
  • The level of loan loss provision is determined based on the level expected to protect the safety and soundness of the bank.

And what is the expected loss-based approach?

  • Under this practice, a bank is required to estimate expected credit losses based on forward-looking estimations, rather than wait for credit losses to be actually incurred before making corresponding loss provisions.
  • As per the proposed framework, banks will need to classify financial assets (primarily loans, including irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale) into one of three categories — Stage 1, Stage 2, or Stage 3.
  • This depends upon the assessed credit losses on them, at the time of initial recognition as well as on each subsequent reporting date, and make necessary provisions.
  1. Stage 1 assets are financial assets that have not had a significant increase in credit risk since initial recognition or that have low credit risk at the reporting date. For these assets, 12-month expected credit losses are recognised and interest revenue is calculated on the gross carrying amount of the asset.
  2. Stage 2 assets are financial instruments that have had a significant increase in credit risk since initial recognition, but there is no objective evidence of impairment. For these assets, lifetime expected credit losses are recognised, but interest revenue is still calculated on the gross carrying amount of the asset.
  3. Stage 3 assets include financial assets that have objective evidence of impairment at the reporting date. For these assets, lifetime expected credit loss is recognised, and interest revenue is calculated on the net carrying amount.

What are the benefits of this approach?

  • The forward-looking expected credit losses approach will further enhance the resilience of the banking system in line with globally accepted norms.
  • It is likely to result in excess provisions as compared to shortfall in provisions as seen in the incurred loss approach.

What is the problem with the incurred loss-based approach?

  • The incurred loss approach requires banks to provide for losses that have already occurred or been incurred.
  • The delay in recognising expected losses under an “incurred loss” approach was found to exacerbate the downswing during the financial crisis of 2007-09.
  • Faced with a systemic increase in defaults, the delay in recognising loan losses resulted in banks having to make higher levels of provisions which ate into the capital maintained precisely at a time when banks needed to shore up their capital.
  • This affected banks’ resilience and posed systemic risks.
  • Further, the delays in recognising loan losses overstated the income generated by the banks which, coupled with dividend payouts, impacted their capital base

 

Which banks are covered under this approach?

  • The proposed norms are for all scheduled commercial banks, excluding regional rural banks.
  • Regional rural banks and smaller cooperative banks (based on a threshold to be decided based on comments) are proposed to be kept out of the framework.

 

Crack Prelims 2023! Talk to our Rankers

(Click) FREE 1-to-1 on-call Mentorship by IAS-IPS officers | Discuss doubts, strategy, sources, and more

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is New Umbrella Entity (NUE) Network?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: New Umbrella Entity (NUE)

Mains level: Read the attached story


umbrella

The Reserve Bank of India (RBI) is said to have put on hold licensing of the New Umbrella Entity (NUE) network, a fintech institution planned as a rival to National Payments Corporation of India (NPCI).

Why in news?

  • Six groupings, which included Facebook, Google, Amazon, Flipkart and others, had applied for NUE licences.

What is New Umbrella Entity (NUE)?

  • NUE is an entity (under the Companies Act 2013) that will manage and operate the new payment system in the retail sector such as ATMs, POS, UPI etc.
  • NUEs will be set up for profit entities that will manage payments in the retail space.
  • These could offer a host of retail payment services, including setting up of ATMs, offering white-label, point of sale terminals, Aadhaar-based payments, remittance services, and develop newer payment methods.
  • They will also manage clearing and settlement systems that could be an alternative to the bank-promoted NPCI.
  • They will be allowed to charge fees for transactions (unlike the existing NPCI).
  • All NUEs will have to be interoperable with the National Payments Corporation of India (NPCI).

Why need NUEs?

  • The NPCI is at the epicentre of the digital payments in the country.
  • RBI has introduced NUEs to end the so-called monopoly of NPCI.
  • The central bank also noted that during the pandemic, with people spending more time at home the usage of e-commerce has increased, and there’s been a significant rise in the incidence of internet fraud, cyber-crimes.

If NPCI is doing its job well, then why NUE?

  • 48% of all electronic retail payments in the country pass through the NPCI infrastructure.
  • RBI’s concern stems from having the operations of so much of the country’s payment system concentrated in one entity.

How will NUE aid Consumers?

  • With the introduction of NUEs, options for payment will increase for users.
  • This will result in more competition and eventually help boost transaction volumes for both platforms as e-commerce expands and reaches deeper into India’s unbanked hinterland.
  • In the World Bank’s most recent report on financial inclusion in 2017, some 190 million Indians did not have a bank account and more than half did not make or receive digital payments.
  • Customers who face frequent sever transaction due to server overload currently have few options.
  • In the new regime, they’ll be able to try the other platform.

What about Data Safety?

  • Compliance as far as data safety and privacy is concerned holds good for all and sundry in the payments and banking space.
  • Every entity involved in payments and settlement have to follow the same set of rules.
  • RBI already have a new set of guidelines on “Regulation of Payment Aggregators and Payment Gateways” .
  • It ensures that neither the authorised Payment Aggregators (PAs) nor the merchants on-boarded by them can store customer card credentials within their database or server to avoid data breaches and potential abuse.

Will NUEs replace NPCI?

  • NUEs will co-exist with NPCI to strengthen the payment infrastructure network.
  • A robust and resilient infrastructure is needed to ensure the government’s ambitious target of one billion digital transactions per day is achieved.
  • NUEs will not replace but complement NPCI in taking India’s digital payment success story to new heights.
  • By establishing a neutral and independent standards-setting body, we can make sure that the system as a whole in our country evolves in the best traditions of digital infrastructure adopted anywhere in the world.

 

Crack Prelims 2023! Talk to our Rankers

(Click) FREE 1-to-1 on-call Mentorship by IAS-IPS officers | Discuss doubts, strategy, sources, and more

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Launching of the Digital Rupee Pilot Project

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Digital Rupee

Mains level: Not Much

rupee

The Reserve Bank of India (RBI) has announced that the first pilot for the retail version of the digital Rupee (e₹-R) would be introduced on December 1, 2022.

Where would be the pilot project launched?

  • The pilot will initially cover the four cities of Mumbai, New Delhi, Bengaluru, and Bhubaneswar, where customers and merchants will be able to use the digital rupee (e₹-R), or e-rupee.
  • Four banks will be involved in the controlled launch of the digital currency in these four cities: State Bank of India, ICICI Bank, Yes Bank, and IDFC First Bank.
  • The service will be subsequently extended to the cities of Ahmedabad, Gangtok, Guwahati, Hyderabad, Indore, Kochi, Lucknow, Patna, and Shimla.
  • Four more banks — Bank of Baroda, Union Bank of India, HDFC Bank, and Kotak Mahindra Bank — will join the pilot.

What is Central Bank Digital Currency (CBDC)?

  • CBDC / Digital Rupee is a RBI bank-issued digital currency which is backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.
  • The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
  • Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.

What are the types of Digital Rupee?

  • Based on the usage and the functions performed by the digital rupee and considering the different levels of accessibility, CBDC can be demarcated into two broad categories:
  1. General purpose (retail) (CBDC-R): It is an electronic version of cash primarily meant for retail transactions. It will be potentially available for use by all — private sector, non-financial consumers and businesses — and can provide access to safe money for payment and settlement as it is a direct liability of the central bank.
  2. Wholesale (CBDC-W): It is designed for restricted access to select financial institutions. It has the potential to transform the settlement systems for financial transactions undertaken by banks in the government securities (G-Sec) segment, inter-bank market and capital market more efficiently and securely in terms of operational costs, use of collateral and liquidity management.

What are the forms of CBDC?

The central bank says e-rupee, or CBDC, can be structured as token-based or account-based.

  1. Token-based CBDC: It would be a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them. In this, the person receiving a token will verify that his ownership of the token is genuine. It is viewed as a preferred mode for CBDC-R as it would be closer to physical cash.
  2. Account-based CBDC: It would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.  In this case, an intermediary will verify the identity of an account holder. This system can be considered for CBDC-W.

What’s the model for issuance?

  • There are two models for issuance and management of CBDCs under the RBI’s consideration — direct model (single tier model) and indirect model (two-tier model).
  • Direct model: Here the central bank will be responsible for managing all aspects of the digital rupee system such as issuance, account-keeping and transaction verification.
  • Indirect model: It would be one where the central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model, the central bank will issue CBDC to consumer’s indirectly through intermediaries and any claim by consumers will be managed by the intermediary.

 

Click and get your FREE Copy of CURRENT AFFAIRS Micro Notes

(Click) FREE1-to-1 on-call Mentorship by IAS-IPS officers | Discuss doubts, strategy, sources, and more

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What are Foreign Currency Non-Resident (FCNR) deposits?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: FCNR Deposits

Mains level: India's forex reserves and its implications

The RBI’s 2013 FCNR scheme to buffer the rupee against steep declines and rebuild foreign exchange reserves is unlikely to prove fruitful in the current crisis as economic fundamentals are different.

What are FCNR deposits?

  • Back in 2013, the RBI had offered to swap the U.S. dollars banks had raised via foreign currency non-resident (FCNR) deposits or foreign currency funding for rupees at concessional rates.
  • A FCNR is a bank account for NRIs to maintain a Fixed Deposit account in India.
  • This account allows one as an NRI to save money earned in the currency form of the country you’ve originally earned the money from.
  • FCNR deposits can hold currencies like US Dollars, Pounds Sterling, Euro, Japanese Yen, Australian Dollars and Canadian Dollars.
  • Interest on such deposits is exempt for income tax.

How do they operate?

  • These deposit accounts are a term deposit account, not savings.
  • Once can withdraw your money before the date of maturity, and there will be no charges, but the interest will not be paid until after a year is complete.

Benefits offered

  • FCNRs are just like what FDs are for resident Indians, except in foreign currency.
  • They work as great investment options for NRIs to invest in the country for a start, before looking for other avenues in investments on the stock market.
  • Because the money is being held in those currencies, the risk of exchange rate fluctuations is eliminated.

Why in news?

  • Forex reserves have tumbled about $110 billion from a peak of $642 billion in September last year.
  • A significant reason behind this is RBI’s currency market intervention.

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What are Digital Banking Units (DBUs)?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Digital Banking Units (DBUs)

Mains level: Read the attached story

dbu

PM has dedicated 75 digital banking units to the nation, taking forward an announcement that was made in the 2022-23 Union Budget.

What are DBUs?

  • A digital banking unit is a specialized fixed point business unit or hub, housing a certain minimum digital infrastructure for delivering digital banking products and services.
  • It aims at servicing existing financial products and services digitally in self-service mode at any time.
  • The RBI has announced the guidelines for DBUs, following the report of a working group of the Indian Banks Association (IBA).

Who can set up these DBUs?

  • Commercial banks (other than regional rural banks, payment banks and local area banks) with past digital banking experience are permitted to open DBUs in tier 1 to tier 6 centres.
  • They are permitted, unless otherwise specifically restricted, without having the need to take permission from the RBI in each case.

What services will be provided by these units?

  • As per the RBI, each DBU must offer certain minimum digital banking products and services.
  • Such products should be on both liabilities and assets side of the balance sheet of the digital banking segment.
  • Digitally value-added services to conventional products would also qualify as such.
  • The services include saving bank accounts under various schemes, current accounts, fixed deposit and recurring deposit accounts, digital kits for customers, mobile banking etc.
  • It also includes- Internet banking, debit cards, credit cards, and mass transit system cards, digital kits for merchants, UPI QR codes, BHIM Aadhaar and point of sale (PoS).

What about lending services?

  • Other services include making applications for and onboarding customers for identified retail, MSME or schematic loans.
  • This may also include end-to-end digital processing of such loans, starting from online application to disbursal and identified government-sponsored schemes that are covered under the national portal.

How will these DBUs compete with fintechs?

  • Currently, fintechs operating as neobanks offer digital banking services but they do so in partnership with non-banking financial companies (NBFCs).
  • Some of the neobanks offering services in India are Jupiter, Fi Money, Niyo, Razorpay X.
  • Compared to conventional banks with online and mobile banking facilities, neobanks or digital banks excel at product innovation and offer far better digital solutions.
  • However, given the arrangement they, some in the industry have pegged these digital banks as “glorified digital distribution companies”.

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Private: Pilot launch of E-Rupee

Note4Students

From UPSC perspective, the following things are important :

Prelims level: E-Rupee (CBDC)

Mains level: Rolling out of digital Rupee

The Reserve Bank of India (RBI) has indicated that it will soon commence limited pilot launches of e-rupee (e`), or Central Bank Digital Currency (CBDC) or digital rupee, for specific use cases.

What’s RBI’s plan?

  • RBI has hinted at two broad categories for the use of e-rupee — retail and wholesale — taking the payment system in the country to a new level.
  • Hence the common people and businesses will be able to use the digital currency seamlessly for various transactions.

What is E-Rupee?

  • E-rupee is the same as a fiat currency and is exchangeable one-to-one with the fiat currency.
  • Only its form is different.
  • It can be accepted as a medium of payment, legal tender and a safe store of value.
  • The digital rupee would appear as liability on a central bank’s balance sheet.

What are the types of E-Rupee?

  • Based on the usage and the functions performed by the digital rupee and considering the different levels of accessibility, CBDC can be demarcated into two broad categories:
  1. General purpose (retail) (CBDC-R): It is an electronic version of cash primarily meant for retail transactions. It will be potentially available for use by all — private sector, non-financial consumers and businesses — and can provide access to safe money for payment and settlement as it is a direct liability of the central bank.
  2. Wholesale (CBDC-W): It is designed for restricted access to select financial institutions. It has the potential to transform the settlement systems for financial transactions undertaken by banks in the government securities (G-Sec) segment, inter-bank market and capital market more efficiently and securely in terms of operational costs, use of collateral and liquidity management.

What are the forms of CBDC?

The central bank says e-rupee, or CBDC, can be structured as token-based or account-based.

  1. Token-based CBDC: It would be a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them. In this, the person receiving a token will verify that his ownership of the token is genuine. It is viewed as a preferred mode for CBDC-R as it would be closer to physical cash.
  2. Account-based CBDC: It would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances. In this case, an intermediary will verify the identity of an account holder. This system can be considered for CBDC-W.

What’s the model for issuance?

  • There are two models for issuance and management of CBDCs under the RBI’s consideration — direct model (single tier model) and indirect model (two-tier model).
  1. Direct model: Here the central bank will be responsible for managing all aspects of the digital rupee system such as issuance, account-keeping and transaction verification.
  2. Indirect model: It would be one where the central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model, the central bank will issue CBDC to consumer’s indirectly through intermediaries and any claim by consumers will be managed by the intermediary.

Advantages of e-rupee

  • The key motivations for exploring the issuance of CBDC in India among others include reduction in operational costs involved in physical cash management.
  • It would foster financial inclusion, bringing resilience, efficiency and innovation in the payments system.
  • It will add efficiency to the settlement system and boost innovation in cross-border payments space.
  • It can provide the public with uses that any private virtual currencies can provide, without the associated risks.

Can e-rupee be transacted in offline mode?

  • The offline functionality as an option will allow CBDC to be transacted without the internet and thus enable access in regions with poor or no internet connectivity.
  • It will also create digital footprints of the unbanked population in the financial system, which will facilitate the easy availability of credit to them.
  • However, the RBI feels in the offline mode, the risk of ‘double-spending’ will exist because it will be technically possible to use a CBDC unit more than once without updating the common ledger of CBDC.
  • But it can be mitigated to a larger extent by technical solutions and appropriate business rules including monetary limits on offline transactions.

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

How Tokenization will change your online purchase?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Tokenization

Mains level: Transaction safety

token

The RBI’s deadline for tokenization of cards used in online payments passed on 30 September.

What is Tokenization?

  • Tokenisation refers to the replacement of credit and debit card details with an alternative code called a ‘token’.
  • This token is unique for a combination of card, token requestor (the entity that accepts a request from the customer for tokenization of a card and passes it on to the card network to issue a token) and the device.

How does it work?

  • Tokenizing credit and debit cards is a way to reduce the number of places where your card data can be found.
  • For instance, payments on Uber showed a warning that your card data will be saved with payment gateways such as Visa and Mastercard.
  • What it is saying is that a merchant like Uber will have to work with payment networks like Visa to convert the card details into a digital token, which is then used to validate transactions.
  • As a result, the card details you enter on the Uber app, or any online platform, are not stored on the company’s cloud servers, and are hence more secure.

What is the digital token being used?

  • The digital token is a randomized string, usually alphanumeric. So, a 16-digit card number gets converted to something like 8f9%yf57ljTa.
  • It is generated by computer programmes, and the card network tags the token to your actual card details, and relays the token to the merchant.
  • When payments are to be requested, the merchant sends this token to the card network, which matches it against the saved details and validates the transaction.
  • A third party accessing the token won’t have use for it, since tokens will be unique across combinations of card, token requestor and merchants.

Who can offer tokenization services?

  • Tokenisation can be performed only by the authorised card network and recovery of original Primary Account Number (PAN) should be feasible for the authorised card network only.
  • Adequate safeguards have to be put in place to ensure that PAN cannot be found out from the token and vice versa, by anyone except the card network.
  • RBI has emphasised that the integrity of the token generation process has to be ensured at all times.

Benefits of Tokenization

  • Transaction safety: Tokenization reduces the chances of fraud arising from sharing card details.
  • Easy payments: The token is used to perform contactless card transactions at point-of-sale (PoS) terminals and QR code payments.
  • Data storage: Only card networks and card-issuing banks will have access to and can store any card data.

How were the transactions processed?

token

  • There are many players involved in processing one card transaction today:
  1. Merchant
  2. Payment aggregator
  3. Issuing bank
  4. Card network
  • When a transaction happens on a merchant platform, the data is sent to the payment aggregator (PA).
  • The PA next sends the details to either the issuing bank or the card network.
  • Then issuing bank sends an OTP and the transaction flows back.

How will tokenization prevent online fraud?

  • Card details saved on an app are stored in cloud servers, which if hacked, can give the hacker access to information like card numbers, expiry dates, name of holder etc.
  • Though most merchants put special mechanisms to store card details in an obfuscated manner, it’s much more difficult to hack a bank or a Visa than it is to hack websites and apps.

How does it differ from encryption?

  • The primary difference is that the token cannot lead one to the card details.
  • In encryption, a computer program obfuscates data using an encryption key, and this key can turn the data back to its original form.
  • In tokenization, however, there is no way to know what data a token represents unless one has access to the databases of the actual issuer of that token.
  • In many cases, laws don’t consider tokens as “sensitive data”, and hence, companies don’t have to ensure the same compliance to protect them.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI hikes Repo Rate by another 50 basis points to 5.9%

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Repo Rate

Mains level: Not Much

repo

The repo rate, the rate at which RBI lends money to commercial banks, has been hiked by 50 basis points again.

What is Repo Rate?

  • Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds.
  • It is used by monetary authorities to control inflation.
  • In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank.
  • This ultimately reduces the money supply in the economy and thus helps in arresting inflation.

How does the repo dynamics work?

  • When there is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the repo rate applicable.
  • The central bank provides these short terms loans against securities such as treasury bills or government bonds.
  • This monetary policy is used by the central bank to control inflation or increase the liquidity of banks.
  • The government increases the repo rate when they need to control prices and restrict borrowings.
  • An increase in repo rate means commercial banks have to pay more interest for the money lent to them and therefore, a change in repo rate eventually affects public borrowings such as home loan, EMIs, etc.
  • From interest charged by commercial banks on loans to the returns from deposits, various financial and investment instruments are indirectly dependent on the repo rate.

Relationship between repo rate and interest rates

  • The relationship between the repo rate paid by the bank to RBI and the interest rates paid by the borrower to the bank is directly proportional.
  • The greater the repo rate, the higher will be the cost of borrowing. Let us understand this with two examples.

Scenario #1: RBI hikes repo rate

  • As of December 2020, the repo rate was 4%. Suppose that RBI increases this to 6%.
  • This means that now, the cost of borrowing from the RBI has increased by 2% or 200 basis points for commercial banks.
  • To compensate for a high cost of borrowing, banks will, in turn, charge a higher interest rate from their borrowers.
  • As a result, loans will become expensive for citizens.

Scenario #2: RBI slashes repo rate

  • Alternatively, if the RBI slashes this rate from 4% to 3.75% (say), banks will be able to afford borrowing more easily than before.
  • They will reduce the interest rates for loans and taking a loan from the bank will become cheaper for citizens.
  • In addition to affecting the interest rates on loan, the repo rate also impacts the returns on direct deposits.
  • If there is a repo rate cut, you will earn a lower interest rate and vice versa.

Try this PYQ:

Q.If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do?

  1. Cut and optimize the Statutory Liquidity Ratio
  2. Increase the Marginal Standing Facility Rate
  3. Cut the Bank Rate and Repo Rate

Select the correct answer using the code given below:

(a) 1 and 2 only

(b) 2 only

(c) 1 and 3 only

(d) 1, 2 and 3

 

Post your answers here.
6
Please leave a feedback on thisx

Back2Basics: Repo Rate vs Bank Rate

  • Bank Rate is charged against loans offered by the central bank to commercial banks, whereas, Repo Rate is charged for repurchasing the securities sold by the commercial banks to the central bank.
  • No collateral is involved while charging Bank Rate but securities, bonds, agreements and collateral is involved when Repo Rate is charged.
  • Repo Rate is always lower than the Bank Rate.
  • An increase in Bank Rate directly affects the lending rates offered to the customer, restricting people to avail of loans and damages the overall economic growth, whereas an increase in Repo Rate is usually handled by the banks and doesn’t affect customers directly.
  • Comparatively, Bank Rate caters to long-term financial requirements of commercial banks whereas Repo Rate focuses on short-term financial needs.

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s attempt to manage currency could prove to be a costly mistake

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Impossible trinity

Mains level: RBI functions

currencyContext

  • A currency defence will also impose costs on the economy.

Why in news?

  • Legally, the Reserve Bank of India is mandated to target an inflation rate. But with the global economic environment taking a turn for the worse, the central bank has also been targeting the exchange rate. This could prove to be a costly mistake.

What is a simple definition for inflation?

  • Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.

What is exchange rate?

  • An exchange rate is a rate at which one currency will be exchanged for another currency. Most exchange rates are defined as floating and will rise or fall based on the supply and demand in the market. Some exchange rates are pegged or fixed to the value of a specific country’s currency.

What is monetary policy?

  • Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied. Economic statistics such as gross domestic product (GDP), the rate of inflation, and industry and sector-specific growth rates influence monetary policy strategy.

What is fixed exchange rate in simple words?

  • A fixed exchange rate is a regime applied by a government or central bank that ties the country’s official currency exchange rate to another country’s currency or the price of gold. The purpose of a fixed exchange rate system is to keep a currency’s value within a narrow band.

currencyWhat is a simple definition of capital?

  • Capital is a broad term that can describe anything that confers value or benefit to its owners, such as a factory and its machinery, intellectual property like patents, or the financial assets of a business or an individual.

What is meant by the impossible trinity?

  • Many economists think of possible policy responses to capital flows in terms of the so-called “impossible trinity,” or “policy trilemma”, according to which, with an open capital account, a central bank cannot simultaneously exercise monetary control and target the exchange rate.

A currency defence will impose costs on the economy?

  • Little economic gain: Some may believe that a stronger currency gives the impression of economic stability and generates confidence in the economy. But there is an inherent contradiction between artificially propping up the rupee and the country’s growth prospects. Very little economic gain will accrue from turning the currency’s value into a political issue.
  • Inflation should be tackled through monetary policy: Understandably, a depreciating currency leads to concerns over higher imported inflation. But inflation should be tackled through monetary policy, while exchange rate management should be linked to growth. Not the other way around.

Significance of currency defence for foreign exchange reserves

  • Decline by 10 per cent: A large part of the current relative strength of the rupee vis-à-vis other currencies is due to the sale of dollars by the RBI  it has lost more than 10 per cent of its foreign reserves in the space of about nine months.
  • Why country needs foreign exchange: A developing economy needs foreign exchange to finance its international transactions for both the current account (goods and services) and capital account (assets) transactions.
  • Cost involved: The benefits of this stock are obvious, but there are also costs associated with the holding of these.

 

https://www.civilsdaily.com/burning-issue-global-trade-in-rupees/We should follow Tenfold Path to manage Exchange Rate Volatility rather monetary policy path

 

(1) Selling dollars

  • The first course of action has been selling dollars in the spot forex market.
  • This is fairly straightforward, but has limits as all crises are associated with declining reserves.
  • While this money is meant for a rainy day, they may just be less than adequate.
  • The idea of RBI selling dollars works well in the currency market, which is kept guessing how much the central bank is willing to sell at any point of time.

(2) NRI deposits

  • The second tool used is aimed at garnering non-resident Indian (NRI) deposits.
  • It was done in 1998 and 2000 through Resurgent India bonds and India Millennium Deposits, when banks reached out asking NRIs to put in money with attractive interest rates.
  • The forex risk was borne by Indian banks.
  • This is always a useful way for the country to mobilize a good sum of forex, though the challenge is when the debt has to be redeemed.
  • At the time of deposits, the rates tend to be attractive, but once the crisis ends, the same rate cannot be offered on deposit renewals.
  • Therefore, the idea has limitations.

(3) Let oil importers buy dollars themselves

  • The third option exercised often involves getting oil importing companies to buy dollars directly through a facility extended by a public sector bank.
  • Its advantage is that these deals are not in the open and so the market does not witness a large demand for dollars on this account.
  • It is more of a sentiment cooling exercise.

(4) Let exporters trade in dollars

  • Another tool involves a directive issued for all exporters to mandatorily bring in their dollars on receipt that are needed for future imports.
  • This acts against an artificial dollar supply reduction due to exporter hold-backs for profit.

(5) Liberalized Exchange Rate

  • The other weapon, once used earlier, is to curb the amount of dollars one can take under the Liberalized Exchange Rate Management System.
  • This can be for current account purposes like travel, education, healthcare, etc.
  • The amounts are not large, but it sends out a strong signal.

(6) Forward-trade marketing

  • Another route used by RBI is to deal in the forward-trade market.
  • Its advantage is that a strong signal is sent while controlling volatility, as RBI conducts transactions where only the net amount gets transacted finally.
  • It has the same power as spot transactions, but without any significant withdrawal of forex from the system.

(7) Currency swaps

  • The other tool in India’s armoury is the concept of swaps.
  • This became popular post 2013, when banks collected foreign currency non-resident deposits with a simultaneous swap with RBI, which in effect took on the foreign exchange risk.
  • Hence, it was different from earlier bond and deposit schemes.
  • Most preferred options by the RBI
  • Above discussed instruments have been largely direct in nature, with the underlying factors behind demand-supply being managed by the central bank.
  • Of late, RBI has gone in for more policy-oriented approaches and the last three measures announced are in this realm.

(8) Allowing banks to work in the NDF market

  • First was allowing banks to work in the non-deliverable forwards (NDF) market.
  • This is a largely overseas speculative market that has a high potential to influence domestic sentiment on our currency.
  • Here, forward transactions take place without real inflows or outflows, with only price differences settled in dollars.
  • This was a major pain point in the past, as banks did not have access to this segment.
  • By permitting Indian banks to operate here, the rates in this market and in domestic markets have gotten equalized.

(9) Capital account for NRI deposits

  • More recently, RBI opened up the capital account on NRI deposits (interest rates than can be offered), external commercial borrowings (amounts that can be raised) and foreign portfolio investments (allowed in lower tenure securities), which has the potential to draw in forex over time.
  • Interest in these expanded contours may be limited, but the idea is compelling.

(10) Settlement in Rupees

  • RBI’s permission for foreign trade deals to be settled in rupees is quite novel; as India is a net importer, gains can be made if we pay in rupees for imports.
  • The conditions placed on the use of surpluses could be a dampener for potential transactions.
  • But the idea is innovative and could also be a step towards taking the rupee international in such a delicate situation.
  • Clearly, RBI has constantly been exploring ways to address our forex troubles and even newer measures shouldn’t surprise us.

Way ahead

  • The RBI (which is in charge of monetary policy) should focus on containing inflation, as it is legally mandated to do.
  • The government (which is in charge of the fiscal policy) should contain its borrowings.
  • Higher borrowings (fiscal deficit) by the government eat up domestic savings and force the rest of the economic agents to borrow from abroad.
  • Policymakers (both in the government and the RBI) have to choose what their priority is containing inflation or being hung up on exchange rate and forex levels.
  • If they choose to contain inflation (that is, by raising interest rates) then it will require sacrificing economic growth. So be prepared for that.

Mains question

Q.What do you understand by the term impossible trinity? How should RBI respond to manage currency exchange rate? Discuss.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Central Bank Digital Currency (CBDC): the Digital Rupee

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Central Bank Digital Currency (CBDC)

Mains level: Prospects and challenges to CBDC

Reports have said the Reserve Bank of India’s (RBI) digital rupee — the Central Bank Digital Currency (CBDC) — may be introduced in phases beginning with wholesale businesses in the current financial year.

What is Central Bank Digital Currency (CBDC)?

  • CBDC is a central bank issued digital currency which is backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.
  • The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
  • Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.

What is Currency chest?

Currency in India is managed by Currency chest. Currency chest is a place where the Reserve Bank of India (RBI) stocks the money meant for banks and ATMs. These chests are usually situated on the premises of different banks but administrated by the RBI.

Why India needs a digital rupee?

  • Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
  • High currency in circulation: India has a fairly high currency-to-GDP ratio.
  • Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.

Why is CBDC preferred over Cryptocurrency?

  • Sovereign guarantee: Cryptocurrencies pose risks to consumers.  They do not have any sovereign guarantee and hence are not legal tender.
  • Market volatility: Their speculative nature also makes them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
  • Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
  • Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
  • Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering.  They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
  • Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread.
  • Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

Features of CBDC

  • High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
  • Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
  • Liability of central bank: It is a liability of the central bank just as physical currency is.
  • Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.

Key benefits offered

  • Faster system: CBDC can definitely increase the transmission of money from central banks to commercial banks and end customers much faster than the present system.
  • Financial inclusion: Specific use cases, like financial inclusion, can also be covered by CBDC that can benefit millions of citizens who need money and are currently unbanked or banked with limited banking services
  • Monetary policy facilitation: The move to bring out a CBDC could significantly improve monetary policy development in India.
  • Making of a regional currency: In the cross border payments domain, India can take a lead by leveraging digital Rupee especially in countries such as Bhutan, Saudia Arabia and Singapore where NPCI has existing arrangements.

Others:

  • It is efficient than printing notes (cost of printing, transporting, and storing paper currency)
  • It reduces the risk of transactions
  • It makes tax collection transparent
  • Prevents money laundering

Issues involved with CBDC

  • Innovation with centralization: The approach of bringing a sovereign digital currency stands in stark contrast to the idea of decentralization.
  • Liability on RBI:  when bank customers wish to convert their deposits into digital rupee, the RBI will have to take these liabilities from the books of banks and onto its own balance sheet.
  • Inflationary risk: Central banks would indulge in issuing more digital currencies which could potentially trigger higher inflation.
  • User adoption: User adoption could also pose a major setback for the smooth roll out of the CBDC in India. The main challenges would always be user adoption and security.
  • Reduced savings: Many, including various central bankers, fear that people may begin withdrawing money from their bank accounts as digital currencies issued by Central banks become more popular.
  • Volatility: the risk is higher and there is more price volatility and lesser acceptance as a money instrument globally, unless the trust factor and investor protection factors change.

Way forward

  • The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
  • The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
  • There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Curbing inflation in tomatoes, onions and potatoes requires streamlining their value chains

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CPI basket in India

Mains level: Paper 3- Inflation challenge

Context

The higher the weight of food in the overall CPI, the more difficult it is for the monetary policy squeeze alone to contain inflation.

Inflation challenge in Indian economy

  • Under the FRBM Act, The RBI has the unenviable task of keeping inflation within the 4+/-2 per cent range.
  • But lately, despite its best efforts, inflation has remained defiant and above its tolerance band.
  • The RBI’s major policy tool, the repo rate has already been hiked by 90 basis points, raising it to 4.9 per cent in June.
  • It is likely to rise to at least 5.5 per cent, if not more, over the course of this financial year.
  • But this will not be enough to tame inflation due to the nature and structure of inflation in India.

How India’s CPI basket is different

  • The CPI basket in India comprises of 299 commodities grouped into six major categories.
  •  The food and beverages group has a weight of 45.86 per cent (with food at 39.06 per cent, prepared meals at 5.55 per cent and non-alcoholic beverages at 1.26 per cent).
  • High weight of food in overall CPI: It is this overwhelmingly high weight of food in overall CPI, based on the consumer expenditure survey (CES) data of 2011-12, that distinguishes Indian inflation from many other developed countries where the food weight is much smaller.
  • It is much lower in Germany (8.5 per cent), the UK (9.3 per cent), the US (13.42 per cent), Canada (15.94 per cent), France (16.49 per cent), Australia (16.8 per cent), China (19.9 per cent), and Japan (26.3 per cent). Even developing nations like South Africa (17.24 per cent), Brazil (25.5 per cent), and Pakistan (34.83 per cent) have lesser weightage of food in overall CPI than India.
  •  The higher the weight of food in the overall CPI, the more difficult it is for the monetary policy squeeze alone to contain inflation.

Tomato inflation

  • Interestingly, of the 299 commodities that comprise CPI, the highest contributor to overall inflation was tomatoes at 8.9 per cent.
  • Inflation in tomatoes was stupendously high at 158.8 per cent (year-on-year).
  • One of the prime reasons was the low base effect as inflation in June 2021 was minus 14.4 per cent.
  • Due to low price realisation last year, this year tomato farmers shifted acreage to other crops.
  • On top of that, some tomato growing areas got flooded, while many others faced heat waves that further depressed tomato supplies.
  •  It is for this reason a scheme called TOP (Tomatoes, Onions, and Potatoes) and allocated Rs 500 crore to streamline their value chains.
  •  But the scheme went to the Ministry of Food Processing, and was expanded to TOTAL by including several other vegetables.
  • Without having a champion, like Verghese Kurien was for milk, this scheme (from TOP to TOTAL) got diffused in focus and has not shown any visible impact in improving the value chains of vegetables.
  • Way forward: The real solution to tomato inflation may lie beyond the ambit of the RBI.
  • Processing: It requires linking tomato value chains to processing of at least 10 per cent of tomato production into tomato paste and puree during bumper years and using them when fresh tomato prices spike.
  • Reduce GST: Further, to enhance the affordability of processed tomatoes, its GST rates need to be reduced from 12 per cent to 5 per cent.
  • This would also help farmers to stabilise their incomes and avoid the typical cobweb problem they face in case of perishables.

Way forward

  • So, monetary policy alone may not be as effective in the Indian case.
  • Revise CPI: India desperately needs to revise its CPI with the latest consumption survey weights.
  • Our parliamentarians must recognise the limitations that the RBI faces in taming inflation.

Conclusion

The upshot of all this is that the nature and structure of inflation in India is different than in developed countries.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI and the rupee: To break a free fall or not to

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Foreign exchange reserves

Mains level: Paper 3- Depreciation of rupee

Context

The Indian rupee has been in free fall. Some commentators have pointed out that it has fallen less against the US dollar than a lot of other currencies.

Significance of foreign exchange reserves

  • Decline by 10 per cent: A large part of the current relative strength of the rupee vis-à-vis other currencies is due to the sale of dollars by the RBI — it has lost more than 10 per cent of its foreign reserves in the space of about nine months.
  • Why country needs foreign exchange: A developing economy needs foreign exchange to finance its international transactions for both the current account (goods and services) and capital account (assets) transactions.
  • Cost involved: The benefits of this stock are obvious, but there are also costs associated with the holding of these.
  •  The larger the stock, the more its reassuring value.
  • Typically, because of their “liquid” nature, the returns on these are low.

How RBI manages the foreign exchange reserves?

  • How country accumulates foreign exchange reserves? A country can accumulate reserves by running current account surpluses that is, keeping its total expenditure below its gross national product, and/or by interventions in the foreign exchange markets.
  • India (usually) runs a current account deficit.
  • Its reserves are then accumulated solely through “sterilised” interventions.
  • When foreign entities want to invest in Indian assets (stocks and debt), the RBI gives them rupees in exchange for foreign exchange.
  • Mindful of the fact that this may cause a surge in inflation, the RBI then sells government bonds, sucking out the additional rupees.
  • The foreign exchange reserves rise, and are matched by an increase in government bonds outstanding.

How outflow of foreign financial capital affects foreign exchange reserves?

  • When capital inflows were taking place, the RBI accumulated foreign exchange and allowed some currency appreciation.
  • As long as capital flows were strong, foreign reserves kept piling up and the currency (in real terms) was strong.
  • Depreciation of rupee: In recent months, we have witnessed an outflow of foreign financial capital, with reserves falling and the rupee depreciating.
  • International capital flows tend to be pro-cyclical, that is, they move with the world economic activity.
  • Unlikely to increase export: A depreciation of our currency is unlikely to see our exports rise very much because the world income levels are down.
  • Inflation: What this depreciation will cause is imported inflation and bankruptcies.

Analysing the RBI’s role

  • Allowed outward remittances: The RBI threw caution to the winds and allowed outward remittances in foreign currency by Indian residents, with almost no questions asked (up to $2,50,000 annually). 
  • The RBI could have had a much larger supply of foreign exchange had they not generously handed out foreign currency to be frittered away.
  • While they have not restricted outward remittances, they are trying to shore up reserves by making FCNR (B) and FRE deposits more attractive.
  • It is not in any individual’s interest to bail out the RBI.
  • The RBI has also committed to using reserves to ensure an orderly depreciation.
  • Futility of RBI’s intervention: If the world financial markets want a depreciated rupee, the RBI’s intervention would not be able to prevent it.
  • But in spite of this, the RBI, with its commitment to inflation targeting, would try to prevent a depreciation (because it causes the price of imported goods to rise).
  • Possible impact on the poor: Having too open a capital account policy was always fraught with risks.
  • When countries are confronted with a crisis, the IMF is asked to provide assistance.
  • But assistance from IMF would involve a “structural adjustment”, including cutting back on subsidies for the poor and vulnerable.

Conclusion

We are standing at the edge of a precipice, but, hopefully, the world will pull back in the nick of time. If not, it would be the chronicle of a death foretold.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: FCNR(B) Account

  • An FCNR ( Foreign Currency Non-resident) account is a type of term deposit that NRIs can hold in India in a foreign currency.
  • FCNR (A) was introduced in 1975 to encourage NRI deposits.
  • The Reserve Bank of India (RBI) guaranteed the exchange rate prevalent at the time of a deposit to eliminate risk to depositors.
  • In 1993, the apex bank introduced FCNR (B), without exchange rate guarantee, to replace FCNR (A).

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI sets up system to settle International Trade in Rupees

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Rupee Settlement System for International Trade

Mains level: Read the attached story

RBI has decided to put in place an additional arrangement of international trade for invoicing, payment, and settlement of exports / imports in INR.

  • Banks acting as authorised dealers for such transactions would have to take prior approval from the regulator to facilitate this.
  • All exports and imports under the invoicing arrangement may be denominated and invoiced in Rupee.
  • Exchange rate between the currencies of the two trading partner countries may be market determined.
  • Exporters and importers can now use a Special Vostro Account linked to the correspondent bank of the partner country for receipts and payments denominated in rupees.
  • These accounts can be used for payments for projects and investments, import or export advance flow management, and investment in Treasury Bills subject to Foreign Exchange Management Act, 1999 (FEMA).
  • Also, the bank guarantee, setting-off export receivables, advance against exports, use of surplus balance, approval process, documentation, etc., related aspects would be covered under FEMA rules.

Nostro and Vostro Accounts

  • Nostro and vostro are terms used to describe the same bank account; the terms are used when one bank has another bank’s money on deposit.
  • They are used to differentiate between the two sets of accounting records kept by each bank.
  • Nostro comes from the Latin word for “ours,” as in “our money that is on deposit at your bank.”
  • Vostro means “yours,” as in “your money that is on deposit at our bank.”

Why such move?

  • The rupee is at a historic low against the dollar.
  • The mechanism is meant to facilitate trade with countries under sanction.
  • Payments had become a pain point for exporters immediately after the Russia-Ukraine war broke out, especially after Russia was cut off from the SWIFT payment gateway.
  • As a result of the trade facilitation mechanism, we see easing of payment issues with Russia.
  • The move would also reduce the risk of forex fluctuation specially looking at the Euro-rupee parity.
  • We see this as a first step towards 100% convertibility of rupee.
  • It will also help stabilize rupee.

What does the change mean for exports?

  • Several countries including Sri Lanka and some in Africa and Latin America are facing forex shortage.
  • As such, the new mechanism will help India promote its exports.
  • It will also help buy discounted crude oil from Russia, which now accounts for 10% of all imported crude.

Will the move help narrow trade deficit?

  • The gap between India’s exports and imports widened to record highs.
  • This puts pressure on the current account deficit, which some economists estimate would nearly double to more than 3% of GDP in FY23.
  • RBI’s decision may not benefit the external account immediately, but over the medium term, demand for dollars may come down.
  • This is partly because opening of new vostro accounts between banks may take some time.

Back2Basics: Currency Convertibility

  • Convertibility is the ease with which a country’s currency can be converted into gold or another currency through global exchanges.
  • It indicates the extent to which the regulations allow inflow and outflow of capital to and from the country.
  • Currencies that aren’t fully convertible, on the other hand, are generally difficult to convert into other currencies.
  • Having a convertible currency allows a government to pay for goods and services in a currency that may not be the buyer’s own.

Convertibility of Rupee

  • In order to face the serious current account deficit in the balance of payments, the Government of India introduced the partial convertibility of rupee from March 1, 1992.
  • This was an inevitable move for the expeditious integration of Indian economy with that of the world.
  • Under this system, 60 per cent of the exchange earnings were convertible in rupees at market-determined exchange rate and the remaining 40 per cent were at the officially determined exchange rate.
  • Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes.
  • Capital account convertibility refers to a similar liberalization of a country’s capital transactions such as loans and investment, both short term and long term.

 

A bit difficult, but pls take an effort to try this PYQ from CSP 2020:

If another global financial crisis happens in the near future, which of the following actions/policies are most likely to give some immunity to India?

  1. Not depending on short-term foreign borrowings
  2. Opening up to more foreign banks
  3. Maintaining full capital account convertibility

Select the correct answer using the code given below:

(a) 1 only

(b) 1 and 2 only

(c) 2 only

(d) 1, 2 and 3

 

Post your answers here. Detailed explanation will be provided.
10
Please leave a feedback on thisx

 

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Why the criticisms of the RBI are misplaced

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not much

Mains level: Paper 3- Inflation targeting

Context

All emerging markets (EMs), including India, are facing outflows of foreign portfolio investment as the US Fed tightens.

Inflatioon and exchange rate

  • Exchange rate as response to capital flow: Canonical inflation targeting wants exchange rates to float as the correct response to capital flows.
  • Policy should respond to exchange rate fluctuations only after they affect inflation or output.
  • Any interest rate defence of the exchange rate would reduce the focus on inflation.
  • But most EMs intervene in foreign exchange (FX) markets in order to reduce volatility.
  • A research paper by Edward F Buffie and co-authors indicate that  FX intervention greatly enhances the efficacy of inflation targeting.
  • Two instruments for two targets work better than trying to do everything through the interest rate.
  • Excess depreciation of currency can raise inflation.
  • Other researches such as from the IMF, argues for the use of prudential capital flow management techniques and finds reserve accumulation and its use reduces risks and crises in EMs.

Policies followed by RBI to reduce volatility

  • Not fully convertible: RBI’s sequenced approach to capital account convertibility, where, for example, debt inflows are only allowed as a percentage of domestic markets, saved it from the kind of interest rate volatility Indonesia experienced during the taper tantrum and is helping it now.
  • More liberalisation measures can be taken when needed.
  • India’s large foreign exchange reserves have allowed rupee depreciation to be lower than most other countries as the dollar strengthens.
  • The cost of holding foreign exchange: There are costs of holding large reserves and of too much intervention.
  • The central bank ends up supporting the US and not its own government borrowing and it sacrifices interest income.
  • But holding reserves and then not using them when required is the most costly.
  • Again use of multiple instruments can mitigate over-reliance on intervention.
  • Much research and recent experience suggest that all available instruments should be used to moderate volatility in nominal variables.

Why increasing interest rates will be ineffective in reducing capital outflow

  •  A common suggestion is to raise policy rates to maintain a historical gap with US Fed rates.
  • But such an interest rate defence did not prevent outflows during the taper tantrum or in 2018 and only triggered a slowdown.
  • It forgets that interest-sensitive flows are only about 8 per cent of India’s foreign liabilities.
  • There have been no debt outflows in 2022 despite a narrowing interest differential.
  • Equity outflows also seem to be tapering.
  • Monetary tightening that dampens expectations of growth, induces more outflows as country risk-premiums rise.

Issues with less intervention

  • Some want less intervention and more rupee depreciation in order to improve the current account deficit.
  •  But less intervention can lead to a chaotic fall and jittery markets as we saw in 2011.
  • It is best for policy to prevent over-depreciation due to global risks.
  • After about 4 per cent nominal depreciation, India’s real effective exchange rate against a basket of 40 countries is approaching 100.
  • That implies the real exchange rate is too depreciated since India has had relatively more structural reform and productivity growth.
  • Future corrections toward equilibrium will require a rise of the rupee.
  • High oil prices are a risk for India’s balance of payments, but multiple types of adjustments have the best chance of succeeding.

Why sometimes policy changes are introduced as surprise?

  • Market participants want clear communication and no surprises for markets.
  • Forward guidance is an important part of inflation targeting. But when markets tend to overreact and are influenced more by the US than by Indian policy, the best way to introduce a policy change may be by surprise.
  • Thus markets had priced in excessive rate hikes after the US Fed began tightening.
  • The steep surprise hike in Indian repo rates prevented additional rate hikes from being priced in as domestic rate-rising began.

Conclusion

Inflation targeting is an art that requires skill, attention to context and an open mind.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: Real Effective Exchange Rate

  • The real effective exchange rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies.
  • The weights are determined by comparing the relative trade balance of a country’s currency against that of each country in the index.
  • An increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper.
  • It is losing its trade competitiveness.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

How the RBI unconventionally innovated policy to fight the pandemic

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Liquidity corrridor

Mains level: Paper 3- RBI innovative approach during pandemic

Context

Recently, the RBI has been at the receiving end for mission the inflation target.

Understanding the RBI’s rationale

  • Supply side shock: Inflation has been largely the result of supply side shocks from vegetable prices, caused by crop damages due to unseasonal rains (tomato, onion and potato) in late 2019 and widespread supply-side disruptions after the outbreak of the pandemic.
  • A narrow-minded focus on inflation caused by supply shocks would have constrained the MPC from supporting growth amidst the unprecedented loss of life and livelihood.
  • Focusing on recovery: Therefore, it was necessary to provide a lifeline to the economy at that juncture by focusing on the recovery.
  • Moreover, the wide tolerance band of 200bps +/- in the inflation targeting framework was specifically designed to accommodate such supply shocks, which provided the flexibility in the flexible targeting (FIT) framework.
  • Taking into account objective of growth: In contrast to a pure inflation targeting framework (inflation nutters), the amended mandate of the RBI under FIT reads as “price stability, taking into account the objective of growth”.
  • Therefore, the MPC was justified in looking through the higher inflation print during the pandemic while trying to resurrect growth.

No contradiction between Governor’s statement and MPC resolution

  • Recently, the MPC highlighted inflation concerns and voted to raise the policy repo rate.
  • The governor’s statement of the same day noted that the RBI will ensure an orderly completion of the government’s borrowing programme.
  • Contradictory objectives: It is said that the above two actions created confusion as lowering inflation and lowering government bond yields are contradictory objectives.
  • This justification is redundant as an orderly completion of the borrowing programme does not imply lowering yields.
  • It basically ensures that the borrowing programme is completed seamlessly at low costs (ensured through auctions).
  • Moreover, from a theoretical perspective, this is not inconsistent because controlling inflation and lowering inflation expectations bodes well for the term premia of bond yields — which moderate once expectations are anchored.
  • Therefore, if inflation is reined in, the government stands to gain in terms of lower interest costs.
  • Was width of corridor lost during pandemic? It is argued that  the MPC kept repo rates unchanged while the RBI changed the reverse repo rate during the pandemic, meaning that the fixed width of the corridor was lost and the MPC lost its role in setting interest rates and so, its credibility.
  • This argument does not stand scrutiny.
  • During the pandemic, the policy repo rate was cumulatively reduced by an unprecedented 115 bps and the interest rate on the overnight fixed-rate reverse repo was reduced cumulatively by 155 bps.
  • Assymetric corridor justified in crises: This measure was not incongruous with contemporary wisdom as an asymmetric corridor has been justified, particularly during crisis times (Goodhart, 2010).
  • Given that elevated inflation concerns precluded the possibility of any further repo rate cuts (cumulatively reduced by 250 basis points since February 2019), financial conditions were eased substantially by reducing the reverse repo rate, which lowered the floor rate of interest in the economy.
  • Since the mandate of the MPC is to control inflation for which the policy instrument is the repo rate, the RBI had used the LAF through changes in the reverse repo rate to alter liquidity conditions.

Trade offs involved in inflation targeting for emerging economies

  • Inflation-targeting countries, because of their sole focus on inflation, experience lower inflation volatility but higher output volatility.
  • Higher output volatility entails a higher sacrifice ratio — the proportion of output foregone for lowering inflation.
  • For an emerging economy, the costs of higher output foregone against the benefits of lower inflation must always be balanced as potential output keeps on changing given the shift of the production function.
  • Developed countries, on the other hand, operate near full employment — therefore, sacrifice ratios are lower.
  • As a result, smoothening inflation volatility is relatively costless for them.

Conclusion

The RBI has innovated admirably under its current stewards during the pandemic, keeping in mind the task of reinvigorating the economy. Despite the existing targeting framework, it did not get fixated on a one-point agenda, daring to look beyond the inflation print.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: Liquidity corridor

  • The Corridor in monetary policy of the RBI refers to the area between the reverse repo rate and the MSF rate.
  • Reverse repo rate will be the lowest of the policy rates whereas Marginal Standing Facility is something like an upper ceiling with a higher rate than the repo rate.
  • The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Need for transparency in RBI’s policy making

Note4Students

From UPSC perspective, the following things are important :

Mains level: Paper 3- Transparency in RBI's policy making

Context

Modern inflation targeting central banks are often bound by explicit statutory mandates. Critics have argued that the RBI ignored its statutory inflation targeting duty.

Why transparency and predictability of the central bank is important?

  • Prior to the 1990s, central banks preferred secrecy.
  • Surprising market: The common wisdom was that the efficacy of monetary policy depended on taking markets by surprise.
  • This belief started changing gradually with the adoption of inflation targeting.
  • Influencing the inflation expectations: Targeting inflation required central banks to influence households’ and firms’ decisions.
  • Thus emerged the need for central banks to be transparent and predictable.

Independence with accountability of the Central bank

  • There was growing international recognition that central banks as monetary authorities should enjoy a relatively higher degree of independence from governments.
  •  In a democratic polity, this could only be expected in exchange for increased accountability.
  • As a result, regulatory governance gradually emerged as a relevant consideration for independent central banks over the last three decades.

Regulatory governance at the RBI

  • The regulatory governance discourse in India came into the focus with the report of the Financial Sector Legislative Reforms Commission in 2013.
  •  Like a state, regulators usually enjoy significant legislative, executive and judicial powers and should be subject to appropriate accountability mechanisms.
  • These should include internal separation of powers; a well-structured regulation making process overseen by the board, through public consultation and cost-benefit analysis; duty to explain its actions to regulated entities and public at large; regular reporting requirements; and judicial review.
  • Based on these recommendations, the Ministry of Finance released a handbook in 2013 for voluntary adoption of these enhanced governance standards by all financial sector regulators.
  • These developments turned the spotlight on the RBI’s regulatory governance.

Reasons for the criticism of the RBI

  • Targeting exchange rate: The central bank appears to have ventured into uncharted legal territory by possibly targeting the exchange rate instead of inflation.
  • Regulatory governance issues: Separately, critics have also highlighted broader regulatory governance challenges at the RBI.
  • For instance, its alleged use of informal nudges to restrict a foreign player’s access to the Indian payment ecosystem goes against an adverse Supreme Court ruling.
  • Such criticisms underline an urgent need to improve the credibility of the central bank’s rule of law quotient.
  • Least responsive in legislative function:  A 2019 research paper found the central bank’s legislative functions to be the least responsive in comparison to three other regulators – SEBI, TRAI and AERA.
  • RBI’ss consultation papers usually presented only one solution and did not offer merits and demerits of multiple possible solutions.

Implications of weak regulatory governance: Judicial scrutiny

  • Weak regulatory governance resulted in weak regulations, inviting judicial scrutiny.
  • Changes in master circular: In 2019, the Supreme Court effectively rewrote RBI’s master circular on wilful defaulters to provide additional procedural safeguards to borrowers.
  •  Striking down of crypto ban: In 2020, the court struck down an RBI circular that sought to ban its regulated entities from dealing or settling in virtual currencies.
  • The court found that the RBI had neither adduced any cogent evidence of the likely harm, nor had it considered any less intrusive alternative before issuing the circular.

RRA 2.0 suggestions for the RBI

  • The recent report of the Regulations Review Authority 2.0 (RRA) offers useful suggestions to improve the central bank’s regulation-making process.
  • The RBI had set up the Review Authority 2.0 (RRA) in April 2021 to streamline its regulations.
  • Skill improvement in regulatory drafting: RRA has advocated for skill development in regulatory drafting inside the RBI.
  • Public consultation: To improve regulatory governance at the RBI, RRA suggested that its regulatory instructions should be issued only after public consultation, except if they are urgent or time sensitive.
  • They must contain a brief statement of objects and reasons clearly explaining the rationale behind their issuance.
  •  Although much softer than the FSRLC standards, RRA nevertheless signal a progressive step forward.

Conclusion

The RBI should heed these recommendations. It should ideally hardcode the suggested principles into a secondary legislation that is binding on itself. That would be the best way to signal that the central bank takes regulatory governance and rule of law seriously.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

With repo rate hike, RBI has done what’s necessary

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CRR

Mains level: Paper 3- Inflation targeting by the RBI

Context

The RBI has decided to take the bull by the horns. It has raised the repo rate by 40 basis points and the cash reserve ratio (CRR) by 50 basis points to fight inflation.

Why major central banks across the world are hiking rates?

  • Across the world, major central banks have of late gone on a rate hike spree, waking up to the realisation of inflationary pressures not being transitory in nature.
  • Record high inflation in the US: The US Fed has been on the offensive battling a 40-year high surge in prices.
  • It has tapered its bond purchase programme drastically while suggesting in no uncertain terms the pace of rate hikes needed to combat inflation.
  • The European Union has been slow to respond but voices are growing to correct the path at the earliest.
  • Banks like the Central Bank of Brazil or the Russian Central Bank have increased the interest rate to double digits.
  • Emerging economies have been doubly hit — the days of easy liquidity are well behind them even as their economic resources remain constrained to support an uneven proportion of population hit by pandemic.
  • Including the RBI’s decision today to push the benchmark rate to align with the current market realities, 21 countries have increased interest rates so far.

Analysing the RBI’s decision to hike interest rates

  • To this extent, the decision by the RBI to frontload the rate hikes ahead of the Fed decision is again an attempt to stem capital outflows.
  • Accommodative policy stance; The most interesting aspect of the rate hike today is the continuation of the accommodative policy stance.
  • The CRR hike may be just an attempt to build up a war chest on the liquidity front.
  • Liquidity inflows to the financial system could be either policy induced by the central bank for example changes in reserves, open market operations etc or non-policy induced such as foreign exchange reserves, government cash balances, and currency in circulation.
  • Given that non-policy induced liquidity inflows have been recently impacted (outflows of portfolio capital) and given the huge size of the government borrowing programme, the RBI also needs to support the market through some means.
  • Impounding bank reserves through the CRR (Rs 87,000 crore) could give some space to the central bank to conduct open market purchases of bonds from banks and thus inject concomitant liquidity some time in the future if the need so arises.
  •  The CRR rate hike is thus an important tool to possibly manage G-sec yields.

Inflation dynamics in India

  • The inflationary pressures can be attributed mainly to adverse cost-push factors, coming from supply-side shocks in food and fuel prices.
  • The RBI statement thus cites food inflation as a major source of discomfort.
  • Additionally, nominal rural wages for both agricultural and non-agricultural labourers picked up during the second half 2021-22.
  • However, such wage growth has remained soft.
  • Measures to ameliorate supply-side cost pressures would be thus critical at this juncture, especially in terms of a calibrated reduction of taxes on petrol and diesel.
  • On the policy side, however, it would mean that even after rate hikes, inflation may continue to remain high for some time.
  • The MCLR (Marginal Cost of Funds based Lending Rate) linked loans have a share of around 53 per cent in the overall loan kitty.
  • With the rise in CRR and expected future hikes in the benchmark rates, there would be an increase in MCLR due to a negative carry.

Conclusion

The RBI has acted prudently in responding to market forces that could impact India’s growth prospects if inflationary concerns were not addressed now. At the same time, by pledging to remain accommodative to spur, and reinvigorate growth, it has reaffirmed its commitment to being a trusted partner in the growth of the country.

UPSC 2023 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI proposes ATM cash withdrawals using UPI

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Features of UPI

Mains level: Success of UPI payments

The RBI’s Monetary Policy Committee (MPC) has proposed to make cardless cash withdrawal facility available at all ATMs, irrespective of banks, through the Unified Payment Interface (UPI).

What is UPI?

  • UPI is an instant real-time payment system developed by National Payments Corporation of India (NPCI) facilitating inter-bank transactions.
  • The interface is regulated by the Reserve Bank of India and works by instantly transferring funds between two bank accounts on a mobile platform.

How will cash withdrawals via UPI work?

  • While the RBI did not disclose specific details on how the process will work, a person having knowledge about the matter said ATMs soon will show an option to withdraw cash using UPI.
  • Upon selecting that option, a user would have to add the amount they wish to withdraw following which a QR code would be generated on the ATM machine.
  • The user would then have to scan that code on their UPI app and enter their pin following which the ATM will dispense cash.

Why such move?

  • Allowing cash withdrawals through UPI would increase the security of such transactions.
  • The absence of the need for physical cards for such transactions would help prevent frauds such as card skimming and card cloning, among others.

What are the current ways of cardless cash withdrawals at ATMs?

  • At the moment, a few banks such as ICICI Bank, Kotak Mahindra Bank, HDFC Bank and SBI, allow their users to withdraw cash from their ATMs without a card.
  • This was a feature introduced in the wake of the Covid-19 pandemic.
  • However, it is a long-drawn process.
  • Users have to install apps of their respective banks and first select the option of cardless cash withdrawal on the app, followed by adding beneficiary details and the withdrawal amount.
  • After confirming the mobile number of a user, the bank will send an OTP and a nine-digit order ID to the beneficiary’s phone.
  • Post that, the beneficiary would have to visit an ATM and key-in the OTP, order ID, amount for transaction and mobile number to get the cash.

Could this impact debit card usage?

  • Debit cards are currently the most popular way of cash withdrawals at ATMs.
  • As of now, there are more than 900 million debit cards in the country, and experts have cautioned that allowing cash withdrawals through UPI could negatively impact debit card usage.
  • There could be a potential first-order impact on debit cards as this step would reduce the need to carry debit cards.

What’s next in the UPI pipeline?

  • It is projected that in the next 3-5 years, UPI would be processing a billion transactions a day, and to enable that, a number of initiatives have been introduced.
  • Chief among these is UPI’s AutoPay feature, which has already seen increased adoption owing to RBI’s disruptive guidelines on recurring mandates.
  • According to industry experts, the AutoPay feature will be crucial to increasing daily transactions on the platform.
  • The RBI has also announced UPI123 on feature phones without an Internet connection, which is expected to open up the payments system to more than 40 crore individuals who use such devices.
  • This will expand digital financial inclusion and add to the number of transactions made on the platform.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is Standing Deposit Facility (SDF)?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Standing Deposit Facility (SDF)

Mains level: Major monetary policy decisions by RBI

The Reserve Bank of India (RBI) introduced the Standing Deposit Facility (SDF), an additional tool for absorbing liquidity, at an interest rate of 3.75 per cent.

What is SDF?

  • In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF – an additional tool for absorbing liquidity without any collateral.
  • By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy.
  • The SDF is also a financial stability tool in addition to its role in liquidity management.
  • The SDF will replace the fixed-rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.
  • Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

How it will operate?

  • The main purpose of SDF is to reduce the excess liquidity of Rs 8.5 lakh crore in the system, and control inflation.
  • The SDF rate will be 25 bps below the policy rate (Repo rate), and it will be applicable to overnight deposits at this stage.
  • It would, however, retain the flexibility to absorb liquidity of longer tenors as and when the need arises, with appropriate pricing.
  • The RBI’s plan is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of monetary policy.

Also read:

What is Reverse Repo Normalization?

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI cannot ignore inflation

Note4Students

From UPSC perspective, the following things are important :

Prelims level: WPI and CPI

Mains level: Paper 3- Inflation challenge

Context

Despite being legally mandated to keep inflation in check, RBI has persisted with easy monetary policy, even as inflationary pressures have increased. We need to understand why, and what could be the repercussions.

Inflation problem in India

  • For most of the past two years, CPI (consumer price index) inflation has been hovering close to the 6 per cent upper threshold of the RBI’s target band.
  • Inflation averaged 6.1 per cent during the pandemic period (April 2020 to June 2021), despite a massive collapse in aggregate demand.
  • Then in January 2022, as food prices recovered, headline inflation once again crossed the upper threshold of the inflation targeting band.
  • Inflationary pressures do not seem to be diminishing either. Instead, they continue to build up.
  • The standard measure of inflation “in the pipeline” is WPI (wholesale price index) inflation, since price increases at the wholesale level tend to translate into retail inflation in due course.
  •  Russia’s invasion of Ukraine has resulted in a sharp increase in global commodity prices, including prices of crude oil, edible oils, and fertilisers.
  • Indian firms are already adapting to this situation, passing on commodity price increase to retail prices.

Issues with RBI’s stance

  • Standard economics gives us a guide for how central banks should react in a situation like this.
  • Two conditions: It says that monetary policy should accommodate the first round of commodity price increase, but only under certain conditions, notably that inflation is initially on target, and expectations are firmly anchored.
  • But neither condition holds at present. Inflation is already too high, and so are expectations.
  • An argument is nonetheless being made that monetary policy should not be tightened when inflation is driven by supply-side factors, as it can adversely impact growth.
  • This is fallacious. When there are supply constraints, using easy monetary policy to boost demand is not going to boost output.
  • And if firms are expecting high inflation, this will send things into a vicious spiral, as they will increase their prices even more in advance of any input price pressures.
  • Surely the RBI is aware of all of this. So why is it still not acting on it?

Why RBI is ignoring inflationary pressure?

  • Growth concerns: The problem seems to be that governments all over the world are worried about growth.
  • The US Federal Reserve has been slow to raise rates even as inflation has reached a four-decade high. The European Central Bank has been even slower to react.
  • Fiscal dominance in India: In India, monetary policy also suffers from a strong fiscal dominance.
  • As a result, not only is the RBI expected to support growth, it is also expected to keep the government’s borrowing costs in check, which is in direct conflict with its inflation targeting objective.

Implications of RBI ignoring inflationary pressure

  • Aggressive reduction in interest rates: A decade ago, we were in a similar situation when RBI delayed its response because it was focusing on growth.
  • When inflation subsequently took off, it reached double digits and the RBI had to raise interest rates aggressively to bring it down.
  • That was a very painful adjustment.
  • Impact on credibility of the RBI: In addition, if the RBI does allow inflation to take off, there will be long-lasting repercussions for its credibility.
  • Unachrored expectation:  if the public sees the RBI consistently ignoring inflation, expectations can rapidly get unanchored, and then it becomes very costly to bring it down.

Conclusion

To conclude, inflation is best addressed by the central bank using monetary policy, not by the government adjusting taxes. The RBI needs to urgently revisit its inflation forecast and its monetary policy stance in order to avoid potentially painful adjustments down the road.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

UPI123Pay: Payment solution for feature phone users

Note4Students

From UPSC perspective, the following things are important :

Prelims level: UPI123Pay

Mains level: UPI payments through feature phones

The Reserve Bank of India has launched a new Unified Payments Interface (UPI) payments solution for feature phone users dubbed ‘UPI123Pay’.

What is UPI?

  • UPI is an instant real-time payment system developed by NPCI facilitating inter-bank transactions.
  • The interface is regulated by the Reserve Bank of India and works by instantly transferring funds between two bank accounts on a mobile platform.

What is UPI123Pay?

  • UPI ‘123PAY’ is a three-step method to initiate and execute services for users which will work on simple phones.
  • It will allow customers to use feature phones for almost all transactions except scan and pay.
  • It doesn’t need an internet connection for transactions. Customers have to link their bank account with feature phones to use this facility.
  • Feature phone users will now be able to undertake a host of transactions based on four technology alternatives.
  • They include calling an IVR (interactive voice response) number, app functionality in feature phones, missed call-based approach and also proximity sound-based payments, the RBI said.
  • Such users can initiate payments to friends and family, pay utility bills, recharge the FAST Tags of their vehicles, pay mobile bills and also allow users to check account balances.
  • Customers will also be able to link bank accounts, set or change UPI PINs.

Others: ‘Digisaathi’

  • A 24×7 helpline for digital payments has also been set up by the National Payments Corporation of India (NPCI).
  • The helpline christened ‘Digisaathi’ will assist the callers/users with all their queries on digital payments via website and chatbot.
  • Users can visit www.digisaathi.info or call on 14431 and 1800 891 3333 from their phones for their queries on digital payments and grievances.

Why UPI123Pay was created?

  • UPI, which was introduced in 2016, has become one of the most used digital payments platforms in the country.
  • The volume of UPI transactions has already reached ₹76 lakh crore in the current year, compared to ₹41 lakh crore in FY21.
  • However, at present, efficient access to UPI is available largely via smartphones.

How will users make payments without internet?

The new UPI payments system offers users four options to make payments without internet connectivity:

  1. Interactive Voice Response (IVR): Users would be required to initiate a secured call from their feature phones to a predetermined IVR number and complete UPI on-boarding formalities to be able to start making financial transactions like money transfer, mobile recharge, EMI repayment, balance check, among others.
  2. App-based functionality: One could also install an app on feature phone through which several UPI functions, available on smartphones, will be available on their feature phone, except scan and pay feature which is currently not available.
  3. Missed call facility: The missed call facility will allow users to access their bank account and perform routine transactions such as receiving, transferring funds, regular purchases, bill payments, etc., by giving a missed call on the number displayed at the merchant outlet. The customer will receive an incoming call to authenticate the transaction by entering UPI PIN.
  4. Proximity sound-based payments: One could utilise the proximity sound-based payments option, which uses sound waves to enable contactless, offline, and proximity data communication on any device.

How do UPI payments through sound work?

  • UPI payments using sound isn’t new. When Google Pay was first launched in 2017 as Tez, the app had a sound-based system of payments built in.
  • Google called this ‘Cash Mode’ in which phones would emit ultrasonic sounds that could be used by other Tez users to accept and receive money.
  • It’s somewhat like Bluetooth but instead of using radio waves, it uses sound waves to transfer data from one device to the next.
  • A company called ToneTag also produces audio-based point-of-sale machines.

Is payment through sound secure?

  • Sound wave-based payments are meant to be contactless, but occur within a certain proximity only.
  • Ultrasonic waves are outside the usual human hearing range, but such payment systems can also use audible sounds, something that US-based startup Chirp showcased back in 2011.
  • Devices using such systems are encrypted, and only the devices involved can recognize the emitted waves.
  • The sound waves being emitted are encrypted, meaning the receiving device will need to have decryption codes to complete the transaction.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is the Digital Rupee?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CBDC, Cryptocurrency

Mains level: Digital Rupee: Prospects and challenges

The Union Finance Minister has announced the launch of the Digital Rupee — a central bank digital currency (CBDC) — 2022-23 onwards.

Who will launch the CBDC?

  • The Reserve Bank of India will launch the CBDC in the upcoming financial year.
  • This follows the government’s plans to launch the CBDC that will be backed by blockchain technology.

What is a CBDC?

  • CBDC is a legal tender issued by a central bank in a digital form.
  • It is similar to a fiat currency issued in paper and is interchangeable with any other fiat currency.
  • One chief difference will be that a Digital Rupee transaction will be instantaneous as opposed to the current digital payment experience.

Features of CBDC

  • High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
  • Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
  • Liability of central bank: It is a liability of the central bank just as physical currency is.
  • Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.

What is the need for CBDC?

  • Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
  • High currency in circulation: India has a fairly high currency-to-GDP ratio.
  • Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
  • The growth of cryptocurrencies such as Bitcoin, Ethereum, etc has raised challenges to fiat currencies.

Key benefits offered

  • Faster system: CBDC can definitely increase the transmission of money from central banks to commercial banks and end customers much faster than the present system.
  • Financial inclusion: Specific use cases, like financial inclusion, can also be covered by CBDC that can benefit millions of citizens who need money and are currently unbanked or banked with limited banking services
  • Monetary policy facilitation: The move to bring out a CBDC could significantly improve monetary policy development in India.
  • Making of a regional currency: In the cross-border payments domain, India can take a lead by leveraging digital Rupee especially in countries such as Bhutan, Saudia Arabia, and Singapore where NPCI has existing arrangements.

Why is CBDC preferred over Cryptocurrency?

  • Sovereign guarantee: Cryptocurrencies pose risks to consumers.  They do not have any sovereign guarantee and hence are not legal tender.
  • Market volatility: Their speculative nature also makes them highly volatile.  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
  • Risk in security: A user loses access to their cryptocurrency if they lose their private key (unlike traditional digital banking accounts, this password cannot be reset).
  • Malware threats: In some cases, these private keys are stored by technical service providers (cryptocurrency exchanges or wallets), which are prone to malware or hacking.
  • Money laundering: Cryptocurrencies are more vulnerable to criminal activity and money laundering.  They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
  • Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread.
  • Power consumption: Since validating transactions is energy-intensive, it may have adverse consequences for the country’s energy security (the total electricity use of bitcoin mining, in 2018, was equivalent to that of mid-sized economies such as Switzerland).

Way forward

  • The launch of CBDCs may not be a smooth affair and still requires more clarity in India. There are still a lot of misconceptions about the concept of digital currency in the country.
  • The effectiveness of CBDCs will depend on aspects such as privacy design and programmability.
  • There is a huge opportunity for India to take a lead globally via a large-scale rollout and adoption of digital currencies.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI approves Offline E-Payments

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Offline E-payments

Mains level: Not Much

The Reserve Bank of India (RBI) has come out with the framework for facilitating small-value digital payments in offline mode, a move that would promote digital payments in semi-urban and rural areas.

Offline E-payments

  • Offline digital payment does not require Internet or telecom connectivity.
  • Such payments can be carried out face-to-face (proximity mode) using any channel or instrument like cards, wallets and mobile devices.
  • Such transactions would not require an Additional Factor of Authentication.
  • Since the transactions are offline, alerts (by way of SMS and/or e-mail) will be received by the customer after a time lag.
  • There is a limit of ₹200 per transaction and an overall limit of ₹2,000 until the balance in the account is replenished.

Conditions applied

  • Payment instruments shall be enabled for offline transactions only after the explicit consent of the customer.
  • That apart, these transactions using cards will be allowed without a requirement to turn on the contactless transaction channel.
  • The customers shall have recourse to the Reserve Bank – Integrated Ombudsman Scheme, as applicable, for grievance redressal.
  • RBI retains the right to stop or modify the operations of any such payment solution that enables small value digital payments in offline mode.

 

Answer this PYQ in the comment box:

Q. With reference to digital payments, consider the following statements:

  1. BHIM app allows the user to transfer money to anyone with a UPI-enabled bank account.
  2. While a chip-pin debit card has four factors of authentication, BHIM app has only two factors of authentication.

Which of the statements given above is/ are correct? (CSP 2018)

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

 

Post your answers here.
5
Please leave a feedback on thisx

 

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

India needs thoughtful legislation on digital currency

Context

The dramatic changes in technology have created new challenges for the law, lawmakers, courts and lawyers to confront.

Challenges posed by technological transformation

  • Technology has outpaced the law, and lawmakers are being challenged by how quickly “we the people” have embraced technological transformations.
  • Challenges of regulation: Challenges include regulation of digital media platforms, censorship of Over The Top (OTT) streaming services, fixing accountability for procuring and deploying spyware like Pegasus, dealing with the bias within artificial intelligence etc.
  • Regulation of cryptocurrencies: In probably no other area are lawmakers required to appreciate science and technology than in cryptocurrency.
  • With 10 crore users of cryptocurrency and crypto assets in India, this ever-expanding market is almost entirely unregulated.

Practices or legislative models that have been adopted the other countries for regulation of cryptocurrencies

  • KYC, AML and CFT: Countries where cryptocurrencies and crypto-assets are legal have frameworks that mandate KYC (know your customer), AML (Anti-Money Laundering) mechanisms and demand adherence to CFT (Combating Financing of Terrorism) requirements.

[1] How Singapore regulates crypto-currencies?

  • Singapore adopted the approach which favours strong regulation rather than ban.
  • Common law to regulate traditional and cryptocurrencies: Singapore has the Payments Services Act, 2020 that has streamlined both traditional and cryptocurrencies under one law.
  • Provision for licences: The law also provides a framework to obtain licences to operate crypto businesses.

[2] How Switzerland regulates cryptocurrencies?

  • Switzerland has also favoured the strong regulation model overseen by an already established financial regulator.
  • Provision for licences: The Swiss Financial Market Supervisory Authority (FINMA) that oversees the country’s financial markets mandates that all virtual asset service providers, including cryptocurrency exchanges must be licenced.
  • KYC, AML and CFT procedures must be strictly complied with. These are the checks on the use of cryptocurrencies and crypto assets that could facilitate criminal enterprise.

[3] Approach adopted by the US

  • Crypto exchanges to be transmitters: The US does not consider cryptocurrency to be legal tender but defines cryptocurrency exchanges to be money transmitters.
  • Cryptocurrencies as property: The Internal Revenue Service (IRS) treats cryptocurrency as property for US federal taxation purposes.
  • Exchanges must obtain requisite licences from the Financial Crimes Enforcement Network and implement the standard AML and CFT requirements that have become the norm in most jurisdictions that regulate cryptocurrencies.
  • Revenue potential: One of the most important lessons to absorb from the US is the revenue potential of cryptocurrencies and crypto assets.

Conclusion

In India, the need of the times is thoughtful legislation and rigorous regulation of cryptocurrencies and crypto-assets that are already here and being used.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is Tokenization of Debit and Credit Cards?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Tokenization

Mains level: Read the attached story

The Reserve Bank of India (RBI) has decided to defer the implementation of tokenization of debit and credit cards for online transactions by a further six months following representations from stakeholders.

RBI decision

  • RBI has also extended tokenization of Card-on-File (CoF) transactions where card details are saved by merchants — and directed the merchants not to store card details in their systems from January 1, 2022.
  • A CoF transaction is one in which a cardholder has authorized a merchant to store his or her Mastercard or Visa payment details, and to bill the stored account.
  • E-commerce companies and airlines and supermarket chains often store card details.

What is Tokenisation?

  • Tokenisation refers to the replacement of credit and debit card details with an alternative code called a ‘token’.
  • This token is unique for a combination of card, token requestor (the entity that accepts a request from the customer for tokenisation of a card and passes it on to the card network to issue a token) and the device.

Benefits of Tokenization

  • Transaction safety: Tokenization reduces the chances of fraud arising from sharing card details.
  • Easy payments: The token is used to perform contactless card transactions at point-of-sale (PoS) terminals and QR code payments.
  • Data storage: Only card networks and card-issuing banks will have access to and can store any card data.

How are the transactions currently processed?

  • There are many players involved in processing one card transaction today:
  1. Merchant
  2. Payment aggregator
  3. Issuing bank
  4. Card network
  • When a transaction happens on a merchant platform, the data is sent to the payment aggregator (PA).
  • The PA next sends the details to either the issuing bank or the card network.
  • Then issuing bank sends an OTP and the transaction flows back.

Which companies dominate card transactions in India?

Is the industry ready to implement this?

  • Not fully, that is why the RBI had to extend the deadline.
  • The industry currently can convert CoF into a tokenized number. However, the readiness to process the token is negligible.
  • About 90% of banks are ready with provisioning of token on Visa. Only 25-30% banks are ready on Mastercard.

Impact on businesses

If the industry isn’t ready, several business models would be impacted.

  • E-mandates (recurring payments) will stand ineffective from 1 July.
  • Card EMIs account for 25% of online e-commerce sales. That option will no longer be available.
  • Cashbacks/discount offers by banks will be impacted, too.
  • A user may not be able to use Mastercard saved cards on a merchant platform to make a transaction and will have to enter the card details every time a transaction is made.
  • This could be the same for some Visa cards.

Way forward

  • The new system is a much bigger disruption to the way digital payments will henceforth be processed.
  • Integration of systems and the ability to process is one part.
  • The industry also needs to test the performance and success rate of the tokenization solution.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Why crypto currency legislations needs careful consideration

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not much

Mains level: Paper 3- Regulating cryptocurrencies and challenges ahead

Context

The government has decided to introduce a bill that seeks to prohibit all private cryptocurrencies in India.

Background of the bill

  • In 2018, the three-judge bench of the Supreme Court set aside the RBI circular that prevented crypto exchanges from dealing with the formal financial system on grounds of proportionality.
  • Purpose of the bill: The current bill now attempts to define the rules of the game so that the RBI, tax authorities, SEBI and other agencies have much better legal guidance in deciding the course of action with respect to VCs in their respective domains.
  • The rules can, therefore, range from a ban to controlled interaction with the formal financial system.

Issues involving cryptos

  • Issues involving cryptos can be seen at three levels, each of which is equally important.
  • The first is its impact on sovereignty.
  • The second is its interaction with financial markets.
  • Third is the value proposition that the entire concept of crypto brings to the economic debate.
  • Incorporation of price stability mechanism: Some of the variants of cryptos such as the stable coin clearly indicate that these are attempts to create systems of money that incorporate features of price stability that imply a parallel monetary system.
  • Diluting the sovereign function of money creation: Unrestricted co-opting of VC clearly dilutes the sovereign function of money creation, clearly impacting the revenues of RBI.
  • Concerns pertaining to money laundering, terrorist threats and narco-trading also come under this category given the high value and anonymity offered by cryptocurrencies.

Challenges in cryptocurrencies interaction with the formal system

  • As of now cryptos have been recognised as assets or commodities and as a medium of exchange. Their role as units of account or legal tender is rather limited.
  • They may offer a store of value given their short supply. From a banking point of view, certain issues do arise.
  • Since VCs are not legal tenders, they cannot be used in the discharge of debt.
  • Thus, banks cannot accept VCs to close a loan account.
  • Second, can banks lend in fiat by accepting VCs as collateral assuming the VC is an asset?
  • Incompatible with the fractional system of banking: At a deeper level, the very idea of VCs and the way they are designed are incompatible with the fractional system of banking.
  • The fluctuations in interbank liquidity require that money supply adjusts to system requirements.
  • If money supply undergoes compositional change in favour of VCs, this ability will be curtailed thus accentuating the crisis.
  • In financial markets, crypto such as ICOs bring another set of issues.
  • The ICO is a creature that disrupts the very concept of limited liability in corporate finance.
  • ICOs are, at times, designed in such a way that the beneficial owner identity is concealed.
  • SEBI is yet to convey a position on various issues surrounding this idea.
  • Issues with making VCs medium of exchange: VCs have emerged as a medium of exchange and many countries have permitted VC ATMs.
  • But how does this proposition fare given that considerable advances have been made in the payment systems domain in India.
  • Is it worthwhile that additional competition is introduced in a market that is hyper-competitive?
  • It will have impact on existing investments in mobile payment and UPI technology.
  • Impact on poor states: It is well known that the Indian population exhibits significant behavioural divergences in their savings and credit behaviour across regions.
  • Such wide behavioural changes have profound implications on bank strategies and product designs.
  • In the past, there have been several instances of states having low per capita income being more prone to chit fund investments that have negatively impacted the savings of many poor households.
  • The issue of consumer protection needs to be addressed and the current laws may have to be reviewed considering this innovation.

Conclusion

The bill must meet many important objectives. While there are obvious concerns of money laundering and benami transactions, there are equal concerns with respect to company laws, payment systems and banking, securities and other commercial laws.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: About Stablecoin

  • Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like the U.S. dollar or gold.
  • This dramatically reduces volatility compared to something like Bitcoin and results in a form of digital money that is better suited to everything from day-to-day commerce to making transfers between exchanges.

What is ICO?

  • ICO stands for “initial coin offering,” and refers to a formerly popular method of fundraising capital for early-stage cryptocurrency projects.
  • In an ICO, a blockchain-based startup mints a certain quantity of its own native digital token and offers them to early investors, normally in exchange for other cryptocurrencies such as bitcoin or ether.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

The brush with crypto offers some lessons for regulation

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Cryptocurrencies

Mains level: Paper 3- Lessons for regulation

Context

The fact that crypto exchanges successfully managed to signal legitimacy for their services and offer these tokens to a mostly-uninformed public for over a year provides lessons on how the government and sectoral regulators may need to act before the game gets out of hand.

Regulating the technology innovation

  • Technology innovation typically remains a step ahead of regulatory frameworks, which are designed with current practices in mind.
  • Problems occur when these innovations push the envelope beyond accepted codes of social and ethical behaviour.
  • Digital lending apps: The joint parliamentary committee (JPC) on a proposed data privacy law that recently released its controversial report has pointed to dubious “digital” lending apps proliferating on the Android platform.
  • Blockchain technology, of which cryptos are a part, is an innovation that can facilitate transactions across assorted functions.

Issues with unregulated cryptocurrencies in India

  • Some estimates show that over 15 million Indians have invested in cryptos, many of whom live in Tier-II or Tier-III towns.
  • But crypto exchanges in India have pushed the boundaries of this invention.
  • Important disclaimer not communicated properly: They have been advertising aggressively across media platforms often announcing important disclaimers at warp speed.
  • These provisos were supposed to communicate that cryptos are neither currencies nor strictly “assets”, and that these trading platforms are not truly “exchanges”, that crypto values are not determined by the usual dynamics governing other income-yielding assets, and that investing in cryptos was an exceedingly risky proposition.
  •  In the meantime, with advertising overload stimulating viewer interest, many scam crypto issuers and exchanges have sprung up in attempts to separate the gullible from their savings.

Regulation challenges and how government is tackling it

  • The government has now stepped in, seized with the political perils of speculative investments turning sour.
  •  Unfortunately, sectoral regulators, such as the Reserve Bank of India (RBI) and Securities Exchange Board of India (Sebi), were unable to step in and act earlier because they are governed by specific Acts which do not mention cryptos as a category that needs regulation.
  • Need for enabling clauses: This episode provides a valuable lesson on how these Acts should perhaps include some enabling clauses that allow financial sector regulators to intervene whenever any intermediary tries to sell a financial service or any new innovative financial service poses the risk of disrupting financial stability.
  • Two important documents have recently been released which discuss entry norms into formal banking, both further strengthening RBI’s hands.
  • Think-tank Niti Aayog’s paper on licensing digital banks recommends an evolutionary path for digital banks that’s RBI-regulated at all stages: first a restricted licence, then a regulatory sandbox offering some relaxations, and finally a “full-stack” digital banking licence.
  • Simultaneously, RBI has accepted some of the suggestions of its internal working group and modified a few to make entry norms stricter, but has maintained silence on the entry of private sector corporate houses into banking.
  • The JPC’s concerns over unregulated digital lending have also focused attention on an RBI-appointed committee’s report on digital lending, given that multiple fintech-based online lenders have mushroomed during the pandemic.

Conclusion

This highlights the need for principle-based regulations, rather than rule-based regulations, to allow for flexibility and adaptability in a fast-changing technology environment.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI panel brings law to regulate Digital Lending

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Digital lending in India

Mains level: Need for regulation of Digital Lending

A Reserve Bank of India (RBI) Working Group (WG) on digital lending has recommended separate legislation to oversee such lending as well as a nodal agency to vet the Digital Lending Apps.

Digital Lending

  • Digital lending is the process of availing credit online.
  • Its increased popularity amongst new-age lenders can be attributed to expanding smartphone penetration, credit range flexibility, and speedy online transactions.

Significance of Digital Lending

India has a huge growth potential when it comes to the Digital Lending landscape:

  • Alternate source of finance: Digital lending is mostly preferred by those who are generally not able to avail any credit through the formal sources of finance, like banks.
  • Lender of the last resort: Digital lending is mostly preferred by those who are generally not able to avail any credit through the formal sources of finance, like banks.
  • Financial inclusion: Digital lending is a powerful tool that can be used for financial inclusion.
  • Cost-efficient lending: With new innovations underway, digital lending offers much better products to the masses at a much faster rate which is even more cost-efficient.
  • Exception for red-tapism: Online lending has played a pivotal role in evading cumbersome red-tapism usually involved while availing loans offline in a traditional setting.
  • Preference by MSMEs: The online lending platforms have gained massive popularity among MSMEs post-Covid as they were unable to secure finance through traditional lending.
  • Easy onboarding: The quick turnaround time and onboarding, easy KYC, as well as disbursement within minutes have attracted the cash-crunched MSMEs towards these digital routes to secure credit.

Issues with Digital Lending

  • No business model: There are many gaps that are existent in this model of digital lending like any new business operation.
  • High interest: Unauthorised lenders provided credit to customers without any collateral and at exorbitant rates coupled with unachievable deadlines to pay off these humongous debts.
  • Coercing and harassment for recovery: Resultantly, borrowers were coerced by the lenders to recollect when they were unable to pay off these debts. We see many cases of suicides due to such harassment.

Key recommendations by RBI

  • Self-Regulation: RBI has mooted a Self-Regulatory Organisation for participants in the digital lending ecosystem.
  • Developing a Baseline Technology: Development of certain baseline technology standards and compliance with those standards as a pre-condition for offering digital lending solutions.
  • Direct loan disbursement: Disbursement of loans directly into the bank accounts of borrowers; disbursement and servicing of loans only through bank accounts of the digital lenders.
  • Data collection: With the prior and explicit consent of borrowers with verifiable audit trails.
  • Standardized code of conduct: for recovery to be framed by the proposed SRO in consultation with RBI.

Way forward

  • There is a growing need for regulation in this space or unauthorized players like pointed out above will keep popping up.
  • Stringent provisions must be formulated which can be enforceable legally.
  • Regulation must be enforced in this industry soon to ensure consumer trust remains unfettered.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is the Retail Direct Scheme for investors in G-Secs?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Integrated Ombudsman Scheme, RBI Retail Direct Scheme

Mains level: Not Much

The RBI has announced proposals for the Retail Direct Scheme for investors in government securities and the Integrated Ombudsman Scheme.

What is the Retail Direct Scheme?

  • Under the scheme, small investors can buy or sell government securities (G-Secs), or bonds, directly without an intermediary like a mutual fund.
  • It is similar to placing funds in debt instruments such as fixed deposits in banks.
  • However, the same tax rules apply to income from G-Secs.

Benefits of RDS

  • With the government being the borrower, there is a sovereign guarantee for the funds and hence zero risk of default.
  • Also, government securities may offer better interest rates than bank fixed deposits, depending on prevailing interest rate trends.
  • For example, the latest yield on the benchmark 10-year government securities is 6.366%.

How can individuals access G-Sec offerings?

  • Investors wishing to open a Retail Direct Gilt account directly with the RBI can do so through an online portal set up for the purpose of the scheme.
  • Once the account is activated with the aid of a password sent to the user’s mobile phone, investors will be permitted to buy securities either in the primary market or in the secondary market.
  • The minimum amount for a bid is ₹10,000 and in multiples of ₹10,000 thereafter. Payments may be made through Net banking or the UPI platform.

Why was it necessary to introduce this scheme?

  • Broader investor base: The scheme would help broaden the investor base and provide retail investors with enhanced access to the government securities market — both primary and secondary.
  • Institutional investment: Accessing retail investors could free up room for companies to bring funds from institutional investors which may otherwise have been cornered by the government.
  • Diverse borrowing for government: This scheme would facilitate smooth completion of the Government borrowing programme in 2021-22.
  • Structural reform: It is a major structural reform placing India among select few countries which have similar facilities.

Why is the RBI setting up an Integrated Ombudsman?

  • Prior to the introduction of this scheme, the RBI had three different ombudsman schemes to aid dispute resolution with respect to banks, NBFCs, and non-bank pre-paid payment issuers (PPIs).
  • They were operated by the RBI through 22 ombudsman offices.
  • The RBI would now appoint the Ombudsman and a Deputy Ombudsman for three years.
  • Complaints may be made either physically to the Centralised Receipt and Processing Centre or the RBI’s offices; or electronically through the regulator’s complaint management system.

Back2Basics: Government Securities

  • These are debt instruments issued by the government to borrow money.
  • The two key categories are:
  1. Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
  2. Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years
  • T-Bills are issued only by the central government, and the interest on them is determined by market forces.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

[pib] Reserve Bank – Integrated Ombudsman Scheme

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Integrated Ombudsman Scheme, RBI Retail Direct Scheme

Mains level: Not Much

The PM will launch two innovative customer-centric initiatives of the Reserve Bank of India.

What are the schemes?

[A] Integrated Ombudsman Scheme

  • It aims to further improve the grievance redress mechanism for resolving customer complaints against entities regulated by RBI.
  • The central theme of the scheme is based on ‘One Nation-One Ombudsman’ with one portal, one email and one address for the customers to lodge their complaints.
  • There will be a single point of reference for customers to file their complaints, submit the documents, track status and provide feedback.
  • A multi-lingual toll-free number will provide all relevant information on grievance redress and assistance for filing complaints.

[B] RBI Retail Direct Scheme

  • It is aimed at enhancing access to government securities market for retail investors.
  • It offers them a new avenue for directly investing in securities issued by the Government of India and the State Governments.
  • Investors will be able to easily open and maintain their government securities account online with the RBI, free of cost.

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI issues revised Prompt Corrective Action (PCA) framework

Note4Students

From UPSC perspective, the following things are important :

Prelims level: PCA framework

Mains level: Paper 3- PCA framework

The RBI has issued a revised Prompt Corrective Action (PCA) framework for banks to enable supervisory intervention at “appropriate time” and also act as a tool for effective market discipline.

What is the PCA framework?

  • Prompt Corrective Action Framework refers to the central bank’s watchlist of weak banks.
  • The regulator imposes restrictions like curbs on lending on such banks.
  • The PCA Framework applies only to commercial banks and does not cover cooperative banks and non-banking financial companies.

When was PCA introduced?

  • The RBI’s PCA Framework was introduced in December 2002 as a structured early intervention mechanism along the lines of the US Federal Deposit Insurance Corporation’s PCA framework.
  • The last PCA Framework was issued by the RBI on April 13, 2017, and implemented with respect to banks’ financials as of March 31, 2017.

Latest PCA norms

  • The revised PCA framework will be effective from January 1, 2022.
  • Capital, asset quality and leverage will be the key areas for monitoring in the revised framework.
  • That apart, RBI has also revised the level of shortfall in total capital adequacy ratio that would push the lender to “risk threshold three” category.

When exactly does a bank fall into this list?

  • The RBI has specified certain regulatory trigger points with respect to three parameters for the initiation of the process:
  • Capital-to-risk weighted assets ratio (CRAR): It is a measure of a bank’s capital to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements.
  • Net Non-Performing Assets (NPA)
  • Return on assets (RoA): It is an indicator of how well a company utilizes its assets in terms of profitability.

What are the trigger points on capital and how does a breach invite action?

1. CRAR

  • If CRAR falls to less than 9 percent, the RBI asks banks to submit a capital restoration plan, restricts new businesses and dividend payments.
  • The RBI also orders recapitalisation, restrictions on borrowings from the inter-bank market, reduction of stake in subsidiaries and reduction of exposure to sensitive sectors.
  • Such sectors include the capital markets, real estate or investments in non-statutory liquidity ratio securities.
  • If CRAR is less than 6 percent but equal to or more than 3 percent, the RBI could take additional steps if the bank fails to submit a recapitalisation plan.

2. NPA levels

  • If net NPAs rise beyond 10 percent but are less than 15 percent, a special drive to reduce bad loans and contain the generation of fresh NPAs begins.
  • The RBI reviews the bank’s loan policy and takes steps to strengthen credit-appraisal skills.

3.Return on assets

  • If RoA is less than 0.25 percent, restrictions on accessing/renewing costly deposits and CDs kick in and the RBI bars the bank from entering new lines of business.
  • The bank’s borrowings from the inter-bank market, making dividend payments and increasing staff will be restricted.

Significance of PCA

  • The financial health of a bank: Essentially PCA helps RBI monitor key performance indicators of banks, and taking corrective measures, to restore the financial health of a bank.
  • Averting a crisis: PCA is intended to help alert the regulator as well as investors and depositors if a bank is heading for trouble. The idea is to head off problems before they attain crisis proportions.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What is a Small Finance Bank?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Small Finance Bank

Mains level: Not Much

The Reserve Bank of India has issued a small finance bank (SFB) license to a consortium of fintech companies BharatPe and Centrum Financial Services Ltd.

What is a SFB?

  • Small finance banks (SFBs) are a type of niche banks in India.
  • They can be promoted either by individuals, corporate, trusts or societies.
  • They are governed by the provisions of Reserve Bank of India Act, 1934, Banking Regulation Act, 1949 and other relevant statutes.
  • They are established as public limited companies in the private sector under the Companies Act, 2013.
  • Banks with a SFB license can provide basic banking service of acceptance of deposits and lending.

Objectives of setting-up an SFB

  • To provide financial inclusion to sections of the economy not being served by other banks, such as small business units, small and marginal farmers, micro and small industries and unorganized sector entities

Key features of SFBs

  • Existing non-banking financial companies (NBFC), microfinance institutions (MFI) and local area banks (LAB) can apply to become small finance banks.
  • The banks will not be restricted to any region.
  • 75% of its net credits should be in priority sector lending and 50% of the loans in its portfolio must in ₹25 lakh.
  • The firms must have a capital of at least ₹200 crore.
  • The promoters should have 10 years’ experience in banking and finance.
  • Foreign shareholding will be allowed in these banks as per the rules for FDI in private banks in India.

Back2Basics: Small Payments Bank Vs. Payment Bank

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI suspends G-Sec Acquisition Programme (GSAP)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Open Market Operations (OMO)

Mains level: NA

The Reserve Bank of India (RBI) has decided to halt its bond-buying under the G-Sec Acquisition Programme (GSAP).

Why such move?

  • The GSAP had succeeded in ensuring adequate liquidity and stabilising financial markets.
  • Coupled with other liquidity measures, it facilitated congenial and orderly financing conditions and a conducive environment for the recovery.

What is GSAP?

  • The G-Sec Acquisition Programme (G-SAP) is basically an unconditional and a structured Open Market Operation (OMO), of a much larger scale and size.
  • G-SAP is an OMO with a ‘distinct character’.
  • The word ‘unconditional’ here connotes that RBI has committed upfront that it will buy G-Secs irrespective of the market sentiment.

What are Government Securities?

  • These are debt instruments issued by the government to borrow money.
  • The two key categories are:
  1. Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
  2. Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years

Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.

Why G-Secs?

  • Like bank fixed deposits, g-secs are not tax-free.
  • They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
  • However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
  • Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Other decisions

  • The RBI, however, remained ready to undertake G-SAP as and when warranted by liquidity conditions.
  • It would also continue to flexibly conduct other liquidity management operations including Operation Twist (OT) and regular open market operations (OMOs).

Answer this PYQ in the comment box:

Q.Consider the following statements:

  1. The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
  2. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
  3. Treasury bills offer are issued at a discount from the par value.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 Only

(c) 2 and 3 only

(d) 1, 2 and 3

 

Post your answers here:
2
Please leave a feedback on thisx

 

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)


Back2Basics: Open Market Operations (OMO)

  • OMOs is one of the quantitative monetary policy tools which is employed by the central bank of a country to control the money supply in the economy.
  • It is a part of the Market Stabilization Scheme (MSS) by the RBI.
  • OMOs are conducted by the RBI by way of sale or purchase of government securities (g-secs) to adjust money supply conditions.
  • The central bank sells g-secs to remove liquidity from the system and buys back g-secs to infuse liquidity into the system.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

[pib] Account Aggregator Network (AAN): A financial data-sharing system

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Account Aggregator Network (AAN) and its regulation

Mains level: Account Aggregator Network (AAN)

The Account Aggregator system in banking has been started off with eight of India’s largest banks. In this newscard, we shall learn it in a FAQ manner.

What is an Account Aggregator?

  • An Account Aggregator (AA) is a type of RBI regulated entity (with an NBFC-AA license) that helps an individual securely and digitally access and share information from one financial institution they have an account with to any other regulated financial institution in the AA network.
  • Data cannot be shared without the consent of the individual.
  • There will be many Account Aggregators an individual can choose between.
  • Account Aggregator replaces the long terms and conditions form of ‘blank cheque’ acceptance with a granular, step by step permission and control for each use of your data.

How would it improve an average person’s financial life?

  • India’s financial system involves many hassles for consumers today.
  • This includes sharing of physical signed and scanned copies of bank statements, stamp documents, or having to share your personal username and password to give your financial history to a third party.
  • The AAN would replace all these with a simple, mobile-based, simple, and safe digital data access & sharing process.
  • This will create opportunities for new kinds of services — eg new types of loans.
  • The individual’s bank just needs to join the Account Aggregator network.

How is AAN different to Aadhaar eKYC data sharing?

  • Aadhaar eKYC and CKYC only allow sharing of four ‘identity’ data fields for KYC purposes (eg name, address, gender, etc).
  • Similarly, credit bureau data only shows loan history and/or a credit score.
  • The AAN allows sharing of transaction data or bank statements from savings/deposit/current accounts.

What kind of data can be shared?

  • Today, banking transaction data is available to be shared (for example, bank statements from a current or savings account) across the banks that have gone live on the network.
  • Gradually the AA framework will make all financial data available for sharing, including tax data, pensions data, securities data (mutual funds and brokerage), and insurance data will be available to consumers.
  • It will also expand beyond the financial sector to allow healthcare and telecom data to be accessible to the individual via AA.

Can AAs view or ‘aggregate’ personal data? Is the data sharing secure?

  • Account Aggregators cannot see the data; they merely take it from one financial institution to another based on an individual’s direction and consent.
  • Contrary to the name, they cannot ‘aggregate’ your data.
  • AAs are not like technology companies which aggregate your data and create detailed profiles of you.
  • The data AAs share is encrypted by the sender and can be decrypted only by the recipient.
  • The end to end encryption and use of technology like the ‘digital signature’ makes the process much more secure than sharing paper documents.

Can a consumer decide they don’t want to share data?

Yes. Registering with an AA is fully voluntary for consumers.

  • If the bank the consumer is using has joined the network, a person can choose to register on an AA, choose which accounts they want to link, and share their data.
  • A customer can reject a consent to share request at any time.
  • If a consumer has accepted to share data in a recurring manner over a period (eg during a loan period), it can also be revoked at any time later as well by the consumer.

Duration of the data shared

  • The exact time period for which the recipient institution will have access will be shown to the consumer at the time of consent for data sharing.

How can a customer get registered with an AA?

  • One can register with an AA through their app or website.
  • AA will provide a handle (like username) which can be used during the consent process.
  • Today, four apps are available for download (Finvu, OneMoney, CAMS Finserv, and NADL) with operational licenses to be AAs.
  • Three more have received in principle approval from RBI (PhonePe, Yodlee, and Perfios) and may be launching apps soon.
  • A customer can register with any AA to access data from any bank on the network.

Does a customer need to pay the AA for using this facility?

  • This will depend on the AA. Some may charge a small user fee.
  • Some AAs may be free because they are charging a service fee to financial institutions.

What new services can a customer access if their bank has joined the AA network of data sharing?

The two key services that will be improved for an individual is access to loans and access to money management.

  • If a customer wants to get a small business or personal loan today, there are many documents that need to be shared with the lender.
  • This is a cumbersome and manual process today, which affects the time taken to procure the loan and access to a loan.
  • Similarly, money management is difficult today because data is stored in many different locations and cannot be brought together easily for analysis.
  • Through Account Aggregator, a company can access tamper-proof secure data quickly and cheaply, and fast track the loan evaluation process so that a customer can get a loan.
  • Also, a customer may be able to access a loan without physical collateral, by sharing trusted information on a future invoice or cash flow directly from a government system like GST or GeM.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Indian Banks join ‘Account Aggregators Network’

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Account Aggregators

Mains level: Read the attached story

Eight of India’s major banks — State Bank of India, ICICI Bank, Axis Bank, IDFC First Bank, Kotak Mahindra Bank, HDFC Bank, IndusInd Bank and Federal Bank has joined the Account Aggregator (AA) network that will enable customers to easily access and share their financial data.

What is an Account Aggregators (AA)?

  • According to the RBI, an AA is a non-banking financial company engaged in the business of providing, under a contract, the service of retrieving or collecting financial information pertaining to its customer.
  • It is also engaged in consolidating, organizing, and presenting such information to the customer or any other financial information user as may be specified by the bank.
  • The AA framework was created through an inter-regulatory decision by RBI and other regulators.
  • These regulators include SEBI, Insurance Regulatory and Development Authority, and Pension Fund Regulatory and Development Authority (PFRDA) through an initiative of the Financial Stability and Development Council (FSDC).
  • The license for AAs is issued by the RBI, and the financial sector will have many AAs.
  • The framework allows customers to avail themselves of various financial services from a host of providers on a single portal based on a consent method, under which the consumers can choose what financial data to share and with which entity.

What does an AA do?

  • Reduce bank traffic: It reduces the need for individuals to wait in long bank queues, use Internet banking portals, share their passwords, or seek out physical notarization to access and share their financial documents.
  • Data security: An AA is a financial utility for the secure flow of data controlled by the individual.
  • Data flow: AA is an exciting addition to India’s digital infrastructure as it will allow banks to access consented data flows and verified data.
  • Reduced cost: This will help banks reduce transaction costs, which will enable us to offer lower ticket size loans and more tailored products and services to our customers.
  • Transaction security: It will also help us reduce fraud and comply with upcoming privacy laws.

How does it work?

  • It has a three-tier structure:
  1. Account Aggregator
  2. FIP (Financial Information Provider) and
  3. FIU (Financial Information User)
  • A FIP is the data fiduciary, which holds customers’ data. It can be a bank, NBFC, mutual fund, insurance repository, or pension fund repository.
  • An FIU consumes the data from a FIP to provide various services to the consumer.
  • An FIU is a lending bank that wants access to the borrower’s data to determine if the borrower qualifies for a loan.
  • Banks play a dual role – as a FIP and as an FIU.
  • An AA should not support transactions by customers but should ensure appropriate mechanisms for proper customer identification.
  • An AA should share information only with the customer to whom it relates or any other financial information user as authorized by the customer

What purpose does it serve?

  • AA creates secure, digital access to personal data at a time when Covid-19 has led to restrictions on physical interaction.
  • It reduces the fraud associated with physical data by introducing secure digital signatures and end-to-end encryption for data sharing.
  • These capabilities in turn open up many possibilities.
  • For instance, whereas physical collateral is usually required for an MSME loan, with secure data sharing via AA, ‘information collateral’ (or data on future MSME income) can be used to access a small formal loan.
  • HDFC Bank and Axis Bank have been using AA for auto loans, Lending Kart for MSME loans, and IndusInd Bank for personal finance management.

What data can be shared?

  • An Account Aggregator allows a customer to transfer his financial information pertaining to various accounts such as banks deposits, equity, mutual fund, and pension funds to any entity requiring access to such information.
  • There are 19 categories of information that fall under ‘financial information, besides various other categories relating to banking and investments.
  • For sharing of such information, the FIU is required to initiate a request for consent by way of any platform/app run by the AA.
  • Such a request is received by the individual customer through the AA, and the information is shared by the AA, after consent is obtained.
  • The AA framework is an excellent initiative that will compile all the digital footprints of the customer in one place and make it easy for lenders like us to access it.
  • It will enable us to provide very quick turnarounds to our customers.

Can an AA see or store data?

  • Data transmitted through the AA is encrypted. AAs are not allowed to store, process and sell the customer’s data.
  • No financial information accessed by the AA from a FIP should reside with the AA.
  • It should not use the services of a third-party service provider for undertaking the business of account aggregation.
  • User authentication credentials of customers relating to accounts with various FIPs shall not be accessed by the AA.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

A way of diluting credit discipline

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not much

Mains level: Paper 3- Current account opening restriction to deal with the NPA issue

Context

Some bank borrowers have gone to court demanding that it quash the Reserve Bank of India (RBI) circular dated August 6, 2020 on opening current accounts.

Background

  • Current accounts with non-lending banks are an important channel for diversion.
  • Diversion of funds is a major reason for large non-performing assets (NPAs).
  • Internal diversion is for non-priority purposes and funds can also be diverted to other firms, owned or controlled by the same group, friends or relatives.
  • To prevent this, the RBI mandates a No-Objection Certificate (NOC) from lending banks before opening such accounts.
  • Banks should verify with CRILC, the RBI credit database, and inform lenders. Banks should also obtain a NOC from the drawee bank when an account is opened through cheques.
  • Widespread non-compliance with mandated safeguards forced the RBI to bar non-lending banks from opening current accounts for large borrowers.
  • Thus, if borrowing is through a cash credit or overdraft account, no bank can open a current account.

What are the current regulations?

  • If a borrower has no cash credit or overdraft account, a current account can be opened subject to restrictions.
  • If the bank’s exposure is less than 10% of total borrowings, debits to the account can only be for transfers to accounts with a designated bank.
  • If total borrowing is ₹50 crore or more, there should be an escrow mechanism managed by one bank which alone can open a current account.
  • Other lending banks can open ‘collection accounts’ from which funds will be periodically transferred to the escrow account.
  • If the borrowing is between ₹5 crore and ₹50 crore, lending banks can open current accounts.
  • Non-lending banks can open collection accounts.
  • If borrowing is below ₹5 crore, even non-lending banks can open current accounts.
  • The working capital credit should be bifurcated into loan and cash credit components at individual bank levels.

Issues with regulations

  • If a borrower has an overdraft, how can there not be a current account?
  • An overdraft is the right to overdraw in a current account up to a limit.
  • The second issue is that the circular forecloses such operational flexibility.
  • Third, why should a bank with low exposure transfer funds to another bank when it can use it to adjust other dues with it?
  • Fourth, share in borrowing is not static. Crossing the threshold both ways could happen often.
  • Fifth, there is a mismatch between what a borrower needs and the regulations allow.
  • Support of non-lending banks through current accounts in other banks is required for large accounts.
  • Sixth, transactions in an active current account enables a bank to monitor a borrower’s account, however small.
  • The lack of such control was why large development financial institutions of yesteryear built up huge NPAs.
  • Seventh, the regulation mandates splitting working capital into loan and cash credit components across all banks.
  • Such a one-size-fits-all regulation does not factor in the purpose of the different facilities.
  • A large company might avail itself of loans in Mumbai, but require current accounts with another bank in Assam where it might have a factory.
  • Lack of flexibility: Rules are not flexible, do not provide for unforeseen circumstances, and can be easily circumvented.
  • Use more generic terms: Regulation needs to use more generic terms. Terms such as Working Capital Term Loan might mean different things in different banks.
  • Diversion of fund is risk better dealt by banks: Is it not better to leave management of exceptional risks such as diversion of funds to the banks?
  • The cost of regulation: the costs of regulation be justified by the benefits.

Conclusion

When regulation ignores market practices, it lacks legitimacy, a construct from neo-institutionalist literature. When legitimacy is wanting, compliance suffers.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Government Securities Acquisition Programme (GSAP 2.0)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: G-Secs

Mains level: Not Much

The Reserve Bank of India (RBI) has announced that it will conduct an open market purchase of government securities of ₹25,000 crore under the G-sec Acquisition Programme (G-SAP 2.0).

Answer this PYQ in the comment box:

Q.Consider the following statements:

  1. The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
  2. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
  3. Treasury bills offer are issued at a discount from the par value.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 Only

(c) 2 and 3 only

(d) 1, 2 and 3

 

Post your answers here:
2
Please leave a feedback on thisx

What are Government Securities?

  • These are debt instruments issued by the government to borrow money.
  • The two key categories are:
  1. Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
  2. Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years

Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.

Why G-Secs?

  • Like bank fixed deposits, g-secs are not tax-free.
  • They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
  • However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
  • Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Positive Pay System for high-value cheques

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Positive Pay System

Mains level: Not Much

Banks have been informing customers about making mandatory, the positive pay system, a process of reconfirming the key details of high-value cheques.

What is the Positive Pay System?

  • The Positive Pay System, developed by the National Payments Corporation of India, is a process of reconfirming the key details of large value cheques.
  • Under this system, a person issuing the high-value cheque submits certain essential details of that cheque like date, name of the beneficiary/payee amount etc. to the drawee bank.
  • The details can be submitted through electronic means such as SMS, mobile app, internet banking, ATM etc.
  • The details are cross-checked while issuing the cheque and any discrepancy is flagged.

Try answering this PYQ:

Q.Which one of the following links all the ATMs in India? (CSP 2018)

(a) Indian Banks’ Association

(b) National Securities Depository Limited

(c) National Payments Corporation of India

(d) Reserve Bank of India

(Note: You need to sign-in to answer this PYQ)

Post your answers here.
5
Please leave a feedback on thisx

What is the limit on the amount for the system?

  • RBI has told banks to enable the facility for all account holders issuing cheques for amounts of ₹50,000 and above.
  • It has also been said that while availing of the facility is at the discretion of the account holder, banks may consider making it mandatory in case of cheque values of ₹5 lakh and above.

Why is this system important for customers?

  • Some banks have been telling customers that if the details of large-value cheques are not pre-registered, the cheque will be returned.
  • On issuance of a high-value cheque, customers should ensure that details are provided within the timeframe prescribed by the banks for hassle-free clearance.
  • RBI has said only cheques that are registered in the Positive Pay System will be accepted under the dispute resolution mechanism.
  • Customers would get an SMS on whether the cheque is accepted or rejected for any reason.

What are the details of the cheque that must be submitted?

  • Account number, cheque number, date of the cheque, amount, transaction code, beneficiary name, MICR CODE.

How can these details be submitted?

  • These details can be submitted through the respective bank’s website, internet banking, or mobile banking.
  • In case a customer does not use electronic banking services, they can submit the details by visiting bank branches.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI working towards ‘phased introduction’ of Digital Rupee

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Digital Rupee

Mains level: Central Bank Digital Currency (CBDC)

The Reserve Bank of India (RBI) is working toward a “phased implementation strategy” of a Central Bank Digital Currency (CBDC).

Do you know?

China’s digital RMB was the first digital currency to be issued by a major economy.

Central Bank Digital Currency (CBDC)

  • The phrase CBDC has been used to refer to various proposals involving digital currency issued by a central bank.
  • They are also called digital fiat currencies or digital base money.
  • The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
  • Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.

Why India needs a digital rupee?

  • Online transactions: India is a leader in digital payments, but cash remains dominant for small-value transactions.
  • High currency in circulation: India has a fairly high currency-to-GDP ratio.
  • Cost of currency management: An official digital currency would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.

Features of CBDC

  • High-security instrument: CBDC is a high-security digital instrument; like paper banknotes, it is a means of payment, a unit of account, and a store of value.
  • Uniquely identifiable: And like paper currency, each unit is uniquely identifiable to prevent counterfeit.
  • Liability of central bank: It is a liability of the central bank just as physical currency is.
  • Transferability: It’s a digital bearer instrument that can be stored, transferred, and transmitted by all kinds of digital payment systems and services.

Various benefits offered

  • It is efficient than printing notes (cost of printing, transporting, and storing paper currency)
  • It reduces the risk of transactions
  • It makes tax collection transparent
  • Prevents money laundering

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI bars Mastercard from issuing new cards

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not much

Mains level: Need for data localization

The Reserve Bank of India (RBI) has banned Mastercard from issuing new debit and credit cards to customers in India.

Why such a ban?

  • According to the RBI, the US card issuer has failed to comply with the local data storage rules announced by the central bank in 2018.

What is the RBI’s data localization policy?

  • In 2018, the RBI had issued a circular ordering card companies such as Visa, Mastercard, and American Express to store all Indian customer data locally.
  • This was aimed for the regulator to have “unfettered supervisory access”.

Why such a policy by RBI?

  • The reason offered by the RBI was that local storage of consumer data is necessary to protect the privacy of Indian users and also to address national security concerns.

Issues with the policy

  • Privacy: Customer privacy and national security are genuine concerns that need to be taken seriously.
  • Protectionism: However, data localization rules may sound too stringent and they could simply be used by governments as tools of economic protectionism.
  • Security: For instance, it may not be strictly necessary for data to be stored locally to remain protected.
  • Formal international laws to govern the storage of digital information across borders may be sufficient to deal with these concerns.
  • Discrimination: Governments, however, may still mandate data localization in order to favour local companies over foreign ones.

Implications of the move

  • Indian banks that are currently enrolled in the Mastercard network are expected to make alternative arrangements with other card companies.
  • The RBI’s data localization policy, as it burdens foreign card companies, may end up favouring domestic card issuers like RuPay, which in turn can lead to reduced competition.
  • Mastercard owns about one-third of the market share in India, and the RBI’s ban is likely to significantly benefit its competitors.
  • This could mean higher costs and lower quality services for customers.

Conclusion

  • In today’s digital economy data have turned out to be a valuable commodity, which companies, as well as governments, have tried to gain control over.
  • With no clear rules on who owns customer data and to what extent, conflicts over data ownership are likely to continue for some time.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

High forex reserves are no guarantee of monetary policy independence

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CAD

Mains level: Paper 3- Forex reserves and its significance

Context

The ascending stock of forex reserves has led to the view this will enable the sole devotion of monetary policy to domestic objectives.

Assessing the significance of forex reserves

Let’s look into the experinec of China and India in this regard.

1) Learning from China’s experience

  • In 2016, China had a strong external position—current account surplus and more than $3tn forex reserves.
  • However, investors’ expectations on renminbi (RMB) value began to shift due to rising concerns about its growth outlook, domestic rate cuts and eventual depreciation, and imminent tightening of US monetary policy, resulting in net capital outflows of $725 billio (bn) over the year.
  • This put sustained pressure upon the RMB.
  • Eventually, China resorted to capital control measures, which slowed the outflow and supported the RMB in the first half of 2017.

2) India’s own historical record

  • India’s own historical record shows that, high or low, forex reserves didn’t prevent investors from reappraising positions.
  • India experienced this in case of oil prices (2018) or taper fears (2013).
  • The CAD was moderate, at 1.1% and 1.4% of GDP in two quarters to December 2017.
  • But as oil prices climbed, current account projections were rapidly revised to 2.5-3% of GDP in less than a quarter seeing the jump in the import bill, lagging exports and continuous outflow of portfolio capital.
  •  Reserves totalled $424 bn then (end-March 2018); foreign currency assets were $399 billion.
  • Against a mere $9 bn capital outflow, the peak-to-trough decline in reserves was $19 bn in April-June 2018, with 5% depreciation of the rupee.
  • The sharper, $21 bn fall in mid-April to July 20, 2018 equalled the reserves decline in April-August 2013 taper episode when the rupee depreciated three times more or 15%!
  • Forex reserves were much lower in 2013 ($255 bn range) and it had taken only a quarter for the current account gap to widen from 4.0% of GDP in April-June 2012 to 5.4% and a record 6.7% in subsequent two quarters to December 2012!

Key takeaways

  • History shows that no level of reserves is a foolproof guarantee for macroeconomic stability or interest rate immunity.
  • The important lesson these episodes hold is that repressive attempts do not always convince markets or prevent shifts in expectations and often compel large, abrupt adjustment.
  • Investors reassess positions, including global factors, whatever the reserves’ stock.
  • The crucial role of reserves is psychological, i.e. market confidence and liquidity insurance that is immediate and unconditional that allows central banks to buy time, whether for a gradual adjustment, soft landing, or as the case may be.

Distortion in bond market and RBI’s role in it

  • RBI has been systematically suppressing bond yields, particularly the 10-year benchmark, the reference rate for banks.
  • So effective was the repression that the bond market became irrelevant as yields altogether stopped responding to inflation or fiscal developments.
  • The 207-basis-point jump in retail inflation in a month in May, which exceeded expectations, caused not even a flicker in the yield premium for example.
  • This did not prevent responses elsewhere though – the overnight indexed swap (OIS), which signals future interest rate movements, increased 20-30 basis points at different tenures with fresh inflation risks.
  • Clearly, the market reading was inconsistent with RBI’s, whose rigid adherence to a particular level (6% in the case of the old, 10-year bond) was disregarded outright.
  • The monetary policy cue was not being accepted, failing to soothe ruffled feathers about inflation.

Risk involved in RBI’s policy

  • If the global financial cycle were to suddenly turn, risk-aversion set in, or oil prices shoot up to risky levels, investors will undoubtedly look at actual differentials, not the one set in stone by RBI.
  • There will be exchange rate pressures, which RBI can no doubt manage with liberal reserves.
  • But the duration and degree of adjustment is not in RBI’s control, identically to the bond market one, where it has infinite capacity to keep local yields where it wants.
  • There’s a limit to how much foreign currency it can sell—the $609bn reserve holding is finite.
  • Currency depreciation can, therefore, worsen a bad situation as higher inflation pressurises domestic interest rates to rise.
  • RBI’s issuance of the new 10-year benchmark bond at 6.10%, which came as a surprise against its previous inflexibility, indicates RBI has internalised the above risks.
  • The disparate movements were undermining RBI,  whose commitment to continue the accommodative monetary policy as long as necessary to revive and sustain growth has been reassuring.

Conlcusion

When the economy is open, financially integrated and subject to cross-country dynamics, it is more prudent to let market forces play out a bit than persist with a stance that could turn unsustainable despite the high reserves.


Back2Basics: What is Current Account Deficit (CAD) ?

  • The current account deficit is a measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the products it exports.
  • The current account includes net income, such as interest and dividends, and transfers, such as foreign aid, although these components make up only a small percentage of the total current account.
  • The current account represents a country’s foreign transactions and, like the capital account, is a component of a country’s balance of payments (BOP).

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Retail Direct Scheme for G-Secs

Note4Students

From UPSC perspective, the following things are important :

Prelims level: G-Secs

Mains level: Not Much

The RBI has announced a scheme under which retail investors will be allowed to open retail direct gilt accounts (RDG) directly with the central bank.

Retail Direct Scheme

  • The scheme is a one-stop solution to facilitate investment in government securities (G-secs) by individual investors.
  • Under RDG schemes, accounts can be opened through a dedicated online portal, which will provide registered users access to primary issuance of government securities and to NDS-OM.

What is a gilt account?

  • A “Gilt Account” means an account opened and maintained for holding Government securities, by an entity or a person including ‘a person resident outside India’ with a “Custodian” permitted by the RBI.

About Government Securities

  • These are debt instruments issued by the government to borrow money.
  • The two key categories are:
  1. Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
  2. Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years

Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.

Why G-Secs?

  • Like bank fixed deposits, g-secs are not tax-free.
  • They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
  • However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
  • Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Retail investors and G-Secs

  • Small investors can invest indirectly in g-secs by buying mutual funds or through certain policies issued by life insurance firms.
  • To encourage direct investment, the government and RBI have taken several steps in recent years.
  • Retail investors are allowed to place non-competitive bids in auctions of government bonds through their Demat accounts.
  • Stock exchanges act as aggregators and facilitators of retail bids.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Government Securities Acquisition Programme (GSAP 2.0)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: GSAP

Mains level: Read the attached story

In a bid to infuse more liquidity in the market, the Reserve Bank of India (RBI) has announced undertake Government Securities Acquisition Program (G-SAP) 2.0 during the second quarter of FY22 and conduct secondary market purchase operations of Rs 1.20 lakh crore.

Answer this PYQ in the comment box:

Q.Consider the following statements:

  1. The Reserve Bank of India manages and services the Government of India Securities but not any State Government Securities.
  2. Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.
  3. Treasury bills offer are issued at a discount from the par value.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 Only

(c) 2 and 3 only

(d) 1, 2 and 3

What are Government Securities?

  • These are debt instruments issued by the government to borrow money.
  • The two key categories are:
  1. Treasury bills (T-Bills) – short-term instruments which mature in 91 days, 182 days, or 364 days, and
  2. Dated securities – long-term instruments, which mature anywhere between 5 years and 40 years

Note: T-Bills are issued only by the central government, and the interest on them is determined by market forces.

Why G-Secs?

  • Like bank fixed deposits, g-secs are not tax-free.
  • They are generally considered the safest form of investment because they are backed by the government. So, the risk of default is almost nil.
  • However, they are not completely risk-free, since they are subject to fluctuations in interest rates.
  • Bank fixed deposits, on the other hand, are guaranteed only to the extent of Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Cryptocurrency & India

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Blockchain technology

Mains level: Paper 3- Adopting and regulating cryptocurrencies

The article highlights the need for coherent cryptocurrency policy and avoid missing the benefits offered by the technology.

Growing dominance of cryptocurrencies

  • Created by Satoshi Nakamoto in 2008, Bitcoin is the most popular cryptocurrency.
  • It is a fully decentralised, peer-to-peer electronic cash system that didn’t need the purview of any third-party financial institution.
  • The Bitcoin, which traded at just $ 0.0008 in 2010, commanded a market price of just under $65,000 this April.
  • Many newer coins were introduced since Bitcoin’s launch, and their cumulative market value touched $ 2.5 trillion this May.
  • Within a span of just over a decade, their value has surpassed the size of economies of most modern nations.
  •  The “cryptomarket” grew by over 500 per cent, even while the pandemic unleashed global economic carnage not seen since the Great Depression.
  • China’s recent crackdown on cryptocurrency had far-reaching consequences.
  • An astounding trillion US dollars were wiped out from the global cryptomarket within a span of 24 hours.
  • This kind of  volatility mentioned above has always been a concern for regulators and investors alike.

India’s approach

  • Law enforcement and taxation agencies have called for a ban, expressing concerns over cryptocurrencies being used as instruments for illicit activities, including money laundering and terror funding.
  • In 2018, the Reserve Bank barred our financial institutions from supporting crypto transactions — but the Supreme Court overturned it in 2020.
  • Yet, Indian banks still block these transactions, and the government has circulated a draft bill outlawing all cryptocurrency activities, which has been under discussion since 2019.
  • The Reserve Bank has announced the launch of a private blockchain-supported official digital currency, similar to the digital Yuan.
  • India is increasingly mimicking China’s paradoxical attempt to centralise a decentralised ecosystem.
  • India is trying to decouple cryptocurrencies from their underlying blockchain technology, and still derive benefit.
  • Unfortunately, this is impractical, and shows a lack of understanding of this disruptive innovation.
  • The funds that have gone into the Indian blockchain start-ups are less than 0.2 per cent of the amount the sector raised globally.
  • The current central government approach makes it near-impossible for entrepreneurs and investors to acquire much economic benefit.

Need for regulation

  • Regulation is definitely needed to prevent serious problems, to ensure that cryptocurrencies are not misused, and to protect unsuspecting investors from excessive market volatility and possible scams.
  •  However, regulation needs to be clear, transparent, coherent and animated by a vision of what it seeks to achieve.
  • India has not been able to tick these boxes, and we’re in danger of missing out in the global race altogether.

Way forward

  • Any new regulations made in this sector should prevent the misuse of these digital assets without hindering innovation and investments.
  • Provisions have to be made to route the value extracted from these networks transparently into our financial system.
  • Regulatory uncertainties over India’s position on cryptocurrency highlights the need for clear-headed policy-making.

Consider the question “India was a late adopter in all the previous phases of the digital revolution be it the semiconductors, the internet or smartphones. Do you think the same is happening again in India’s adoption of cryptocurrencies and blockchain technology?”

Conclusion

We are currently on the cusp of the next phase, which would be led by technologies like blockchain. We have the potential to channel our human capital, expertise and resources into this revolution, and emerge as one of the winners of this wave. All we need to do is to get our policymaking right.

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI steps in to ease COVID-19 burden

Note4Students

From UPSC perspective, the following things are important :

Prelims level: SLTRO

Mains level: Paper 3- RBI measures to mitigate the impact of second Covid wave

Term Liquidity Facility announced

  • Reserve Bank of India stepped in on Wednesday with measures aimed at alleviating any financing constraints for healthcare infrastructure and services reeling under the second Covid wave.
  • RBI Governor announced a Term Liquidity Facility of ₹50,000 crore with tenor of up to three years, at the repo rate, to ease access to credit for providers of emergency health services.
  • Under the scheme, banks will provide fresh lending support to a wide range of entities, including vaccine manufacturers, importers/suppliers of vaccines and priority medical devices, hospitals/dispensaries, pathology labs, manufacturers and suppliers of oxygen and ventilators, and logistics firms. 
  • These loans will continue to be classified under priority sector till repayment or maturity, whichever is earlier.

Measures for individual and MSME borrowers

  • As part of a “comprehensive targeted policy response”, the RBI also unveiled schemes to provide credit relief to individual and MSME borrowers impacted by the pandemic.
  • RBI unveiled a Resolution Framework 2.0 for COVID-related stressed assets of individuals, small businesses and MSMEs.
  • To provide further support to small business units, micro and small industries, and other unorganised sector entities the RBI decided to conduct special three-year long-term repo operations (SLTRO) of ₹10,000 crore at the repo rate for Small Finance Banks.
  • The SFBs would be able to deploy these funds for fresh lending of up to ₹10 lakh per borrower.
  • In view of the fresh challenges brought on by the pandemic and to address the emergent liquidity position of smaller MFIs, SFBs are now being permitted to reckon fresh lending to smaller MFIs (with asset size of up to ₹500 crore) for onlending to individual borrowers as priority sector lending.

Measure for States

  • To enable the State governments to better manage their fiscal situation in terms of their cash flows and market borrowings, maximum number of days of overdraft (OD) in a quarter is being increased from 36 to 50 days and the number of consecutive days of OD from 14 to 21 days, the RBI said.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI to strengthen risk-based supervision (RBS) of banks, NBFCs

Note4Students

From UPSC perspective, the following things are important :

Prelims level: CAMELS model

Mains level: Paper 3- Strengthening risk-based supervision of banks, NBFC

About RBS model

  • The RBI uses the Risk-Based Supervision (RBS) model, including both qualitative and quantitative elements, to supervise banks, urban cooperatives banks, non-banking financial companies and all India financial institutions.

Decision to review the model

  • The Reserve Bank has decided to review and strengthen the Risk-Based Supervision (RBS) of the banking sector with a view to enable financial sector players to address the emerging challenges.
  • The review process will help make the extant RBS model more robust and capable of addressing emerging challenges, while removing inconsistencies if any.
  •  Annual financial inspection of UCBs and NBFCs is largely based on CAMELS model (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Systems & Control).
  • It is intended to review the existing supervisory rating models under CAMELS approach for improved risk capture in a forward-looking manner and for harmonising the supervisory approach across all Supervised Entities.

Source:

https://www.financialexpress.com/industry/banking-finance/rbi-to-strengthen-risk-based-supervision-of-banks-nbfcs/2244259/

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Covid fear and anxiety spread, cash back in favour with public

Note4Students

From UPSC perspective, the following things are important :

Prelims level: What constitute M3

Mains level: Paper 3- Increase in currency with public

Increase in currency with the public

  • During the fortnight ended April 9, currency with the public jumped by Rs 30,191 crore to hit a new high of Rs 27,87,941 crore.
  • In the six-week period between February 27 and April 9, currency with the public rose by Rs 52,928 crore, show RBI data.
  • Experts said the increase in currency with the public is on account of the fear of imposition of lockdowns by state or central governments.

How currency with public is arrived at

  • According to the RBI, currency with the public is arrived at after deducting the cash with banks from the total currency in circulation.
  • Currency in circulation, which includes notes in circulation, rupee coins, and small coins, refers to cash or currency within a country that is physically used to conduct transactions between consumers and businesses.
  • It effectively means the currency that individuals across the country hold with themselves.

M3 has gone up

  • Money supply in the economy – or M3 – has gone up over the last couple of months.
  • M3, which includes currency with public, current deposits, savings deposits, and fixed deposits, has increased by 11.3 per cent, or Rs 19.17 lakh crore, to a new high of Rs 189.07 lakh crore as on April 9, 2021.

B2BASICS

Measures of Money supply

  1. Reserve Money (M0): It is also known as High-Powered Money, monetary base, base money etc.
    M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI
    It is the monetary base of economy.
  2. Narrow Money (M1):
    M1 = Currency with public + Demand deposits with the Banking system (current account, saving account) + Other deposits with RBI
  3. M2 = M1 + Savings deposits of post office savings banks
  4. Broad Money (M3)
    M3 = M1 + Time deposits with the banking system
  5. M4 = M3 + All deposits with post office savings banks

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Cybersecurity norms for payment services

Note4Students

From UPSC perspective, the following things are important :

Prelims level: NPCI

Mains level: Paper 3- Cybersecurity norms for payment systems

What prompted RBI to take such step

  • Following a series of data breaches faced by operators including Mobikwik and payment aggregator JusPay, the Reserve Bank of India (RBI) will soon issue cybersecurity norms for payment service providers (PSPs).
  • On cyber frauds, Reserve Bank of India has issued very recently basic guidelines on cyber hygiene and cybersecurity for banks and certain NBFCs,
  • The standards for fintech-driven payment services providers will be similar to these cyber hygiene norms issued recently.
  • the critical challenge for regulators would be to speed up the absorption of fintech without undermining the financial system’s integrity or stability.

UPI dominated by limited players

  •  There are not too many payment systems in India and the number of players is limited.
  • Two apps provide about 70% of third-party services in the UPI system.
  • The concentration of two or three third-party providers in this retail payments space could give rise to competitive weaknesses. 
  • Therefore, the National Payments Corporation of India (NPCI) had laid down a framework for a more even distribution of share of third-party app providers in the UPI system.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI extends Ways and Means credit for States, UTs to Sept

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Consolidated Sinking Fund (CSF)

Mains level: Paper 3- RBI extends WMA scheme

About Ways and Means credit

  • Simply put, it is a facility for both the Centre and states to borrow from the RBI.
  • WMAs are temporary advances given by the RBI to the government to tide over any mismatch in receipts and payments.
  • Section 17(5) of the RBI Act, 1934 authorises the central bank to lend to the Centre and state governments subject to their being repayable “not later than three months from the date of the making of the advance”.

Extension of the scheme

  • The RBI decided to continue with the existing interim Ways and Means Advances (WMA) scheme limit of ₹51,560 crore for all States/ UTs shall for six months given the prevalence of COVID-19.
  • Based on the recommendations of the Advisory Committee on WMA to State Governments, 2021 — chaired by Sudhir Shrivastava — the RBI had revised the WMA Scheme of States and Union Territories (UTs).
  • The WMA limit arrived at by the Committee based on total expenditure of States/ UTs, works out to ₹47,010 crore. 

What RBI said about SDR

  • The RBI further said Special Drawing Facility (SDF) availed by state governments and UTs will continue to be linked to the quantum of their investments in marketable securities issued by the Government of India.
  • The net annual incremental investments in Consolidated Sinking Fund (CSF) and Guarantee Redemption Fund (GRF) will continue to be eligible for availing of SDF, without any upper limit.
  • CSF and GRF are reserve funds maintained by some State Governments with the Reserve Bank of India.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

U.S. currency watchlist an intrusion into RBI’s policy space

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Currency watchlist

Mains level: Paper 3-Currency watchlist of the US and RBI's role

Why was India put on the currency watchlist by the US

  • The U.S. Treasury Department had recently retained India in a watchlist for currency manipulators submitted to the U.S. Congress.
  • It cited higher dollar purchases (close to 5% of the gross domestic product) by the Reserve Bank of India (RBI).
  • Another trigger for the inclusion in the currency watchlist is a trade surplus of $20 billion or more.

What is India’s position

  • India had a steady holding pattern of forex reserves ‘with ups and downs’ based on market-based transactions that central banks may undertake.
  • The central bank’s activity in the foreign exchange market has been perfectly balanced and completely legitimate within the accepted monetary policy mandate of central banks across the world.
  • It is a mandate of the central bank to provide stability in the currency as a result of which central banks buy and sell foreign currency.
  • Our overall reserves have been fairly steady at $500 bn to $600 bn.
  • We are not accumulating reserves like China.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Government Securities Acquisition Programme (G-SAP)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Government Securities Acquisition Programme (G-SAP)

Mains level: Open market operations

What is the first phase of operation?

  • The RBI has officially notified that it would conduct the first phase of G-SAP 1.0 operations on April 15, 2021.
  • It will begin with the purchase of five dated securities for an amount aggregating to Rs 25,000 crore.
  • The first phase of G-SAP purchase will happen using the multiple price method under which the bidders pay at the respective rate they had bid.
  • The RBI has notified four securities for the G-Sec purchase in different maturities.
  • In addition to the G-SAP plan, the RBI will also continue to deploy regular operations.
  • This would be under the LAF, longer-term repo/reverse repo auctions, forex operations and open market operations including special OMOs.
  • This is to ensure that the liquidity conditions evolve in consonance with the stance of monetary policy.

What are the concerns?

  • Interest rates – For the Government, the RBI keeping the yield down is a good news because the overall borrowing costs go down.
  • But, the RBI artificially keeping the interest rates lower in the financial system has caused concerns.
  • In healthy economic system, the interest rates pricing should be driven by demand-supply.
  • It shouldn’t be artificially suppressed by the central bank; this might lead to distortions and have other consequences.
  • Savers – Cheaper rates will be good news to big, top rated companies who can issue bonds to raise money and to the government.
  • But low interest rates coupled with high inflation is a systemic worry for savers.
  • Already, savers are getting negative returns on their deposits if one takes into account the inflation adjusted rates or real rates.
  • Rupee – Government resorting to massive bond purchase to keep the rates low is not good news for the local currency.
  • The Indian Rupee, notably, came under pressure after the RBI announced the massive Rs 1 lakh crore bond purchase programme.
  • The fear of investors pulling capital out of India in a low interest environment is hurting the local currency.

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What India needs for population stabilisation

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Replacement level of fertility

Mains level: Paper 1- Population stabilisation

Achieving replacement levels of fertility

  • The National Population Policy 2000 affirmed a commitment to achieve replacement levels of fertility (total fertility rate of 2.1) by 2010.
  • Ten states — Karnataka, Punjab, Gujarat, Assam, Telangana, Andhra Pradesh, West Bengal, Maharashtra, Tamil Nadu and Kerala — and Jammu and Kashmir, have achieved this goal.
  • This fertility decline over half of India has cut across all sections of society — the privileged and the poor, those educated or not, and the high and low caste.
  • The National Family Health Survey-4 has shown how TFR has reduced even among illiterate women from all religions in the southern states.

Growing gap between North-South

  • The difference between the progressive South and the Central- North is becoming disproportionately skewed.
  • UP and Bihar are 23 per cent of India’s population and are projected to grow by over 12 per cent and 20 per cent in the next 15 years.
  • Their high TFR pervades all religious groups.
  • Action to prevent unwanted pregnancies particularly in these two Hindi belt states is urgently required.
  • For decades UP has had a dedicated agency — SIFPSA (State Innovations in Family Planning Services Agency). But its website gives dated information.
  • Women in rural UP are still giving birth to four or more children.
  • In some districts, the contraceptive prevalence rate is less than 10 per cent.
  • In many districts neither Hindus nor Muslims use modern family planning methods.
  • In such a scenario, demographics will eclipse economic growth and destroy the gains from a young populace.
  • UP’s over-reliance on traditional methods of contraception needs to be swiftly replaced with reliable and easy alternatives.
  • Bihar has the highest fertility rate in the country and also the highest outmigration.

Which method  should be used

  • While national and state policies emphasise male vasectomy, politicians never champion its adoption.
  • No other country in the world uses female sterilisation as excessively as India.
  • Indonesia and Bangladesh introduced injectables right from the late 1980s but India only did so in 2016.
  • Executed properly, one jab renders protection from pregnancy for three months.
  • This method needs greater impetus given the helplessness of women who carry the burden of unwanted pregnancies.

Way forward

  • Three things are needed:
  • 1) Incentivise later marriages and child births.
  • 2) Make contraception easy for women.
  • 3) Promote women’s labour force participation.
  •  Some other disturbing nationwide trends must also be counteracted without delay because stabilisation isn’t only about controlling population growth.
  • A balanced sex ratio is essential to secure social cohesion.
  • The inheritance law favouring women’s rights to ancestral property is far from being implemented.
  • And then there is ageing. Paradoxically, it is the Southern states that will face problems in future.
  • Having largely redeemed their demographic dividend, the cohort of the elderly will start outstripping the working age population.
  • The theoretical possibility that younger people from the Central-Northern states may fill the growing gap in services will need strong political support.
  • The freeze on the state-wise allocation of seats in Parliament until 2026 was extended through the Constitutional (84th Amendment) Act, 2002, to serve “as a motivational measure to pursue population stabilisation”.
  • This goal has not been achieved.
  • In the absence of further extension, it will be politically destabilising.

Consider the question “India’s efforts at populations stabilisation still remains work in progress, as the Northern states fail to achieve the targets. Suggest the ways to deal with the issue.”

Conclusion

The population momentum, if managed properly in the Hindi belt, will remain India’s biggest asset until 2055. By 2040, India will be the undisputed king of human capital.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

The formidable challenge of reversing a liquidity glut

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Monetary policy measures

Mains level: Paper 3- Dealing with the excess liquidity

The article highlights the challenge in dealing with the excess liquidity in the economy after the central banks injected liquidity by persuing unorthodox policies.

Overview of policies adopted during 2008 financial crisis

  • Days after the crash of Lehman Brothers, the United States Congress approved an emergency bailout package of $700 billion in September 2008.
  • The amount was used to buy off mortgage-backed securities from banks, hedge funds and pension funds to avert further Lehman-type bankruptcies.
  • As a result, fresh money was injected into the banking system for it to resume normal credit operations and clean up balance sheets.
  • Subsequent actions of the US government and Federal Reserve blurred the distinction between fiscal and monetary policy.
  • ‘Quantitative easing’  was a term coined to describe unorthodox measures like a central bank buying off mortgages and loans, and thus taking credit risk onto its balance sheet.
  • So, quantitative easing was pursued by all the major central banks of the developed world.
  • Central banks embarked upon an aggressive money-printing spree. Assets on their books ballooned.

Monetary response during pandemic subsequent liquidity glut

  • During the pandemic year more than a decade after the 2008 crisis, the West’s monetary spigots have been opened even more.
  • A liquidity glut has ensued.
  • While the rate of monetary expansion over this period has been healthy, neither employment nor economic output grew by even a fraction of that rate.
  • Central bank finds itself in the maze.

RBI in a similar situation

  • The Reserve Bank of India (RBI) too finds itself in a similar predicament, where the way out of its liquidity glut is hazy.
  • Due to purchases of foreign exchange externally and of government bonds domestically, RBI’s balance sheet has ballooned by more 30% by August last year.
  • RBI has injected liquidity through long-term repo operations, which essentially provide long-term money at low overnight rates.
  • The Indian central bank has also provided implicit liquidity support to mutual funds.
  • However, the RBI has not quite ventured into taking credit risk onto its books, nor has it signalled a readiness to buy toxic assets.

Liquidity glut and challenges associated with it

  • As a result of India’s liquidity glut, money is flowing in and out of the central bank to the tune of 7 trillion on a daily basis.
  • This has resulted in an anomaly: market lending rates have gone below RBI’s reverse repo rate, which is supposed to be the de facto floor.
  • Cheap money encourages to do foolish and risky things, which, if done widely and voluminously enough, can spell disaster for financial stability.
  • But, any hint of reducing the rate of money expansion threatens to cause panic and burst the bubble it blew.
  • So, when RBI tentatively tried to move market rates higher by announcing a reverse repo auction,the market reaction was one of panic all the same, and there was a spike in interest rates.
  • This caused the central bank to rethink its strategy.
  • To calm nervous bond traders, the governor has categorically said that liquidity support will continue as long as necessary.

Way forward

  •  We need to plan an exit from the current glut.
  • One way out could be loan 5 trillion to the central government against shares of public sector undertakings, at a low rate of 3% for a period of five years to fund its huge deficit.
  • That will bypass markets and not cause any disruption to interest rates.

Consider the question “Why the challenges posed by liquidity glut caused by the unorthodox policies adopted by the central bank in the aftermath of the pandemic? What are the challenges in reducing the liquidity?” 

Conclusion

Whatever the way out of this whirlpool of liquidity, it’s not going to be easy.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Secured Overnight Financing Rate (SOFR)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: SOFR and various inter-bank rates

Mains level: Not Much

State Bank of India (SBI) has executed two inter-bank short term money market deals with pricing linked to SOFR (Secured Overnight Financing Rate).

Try this PYQ:

Q.The money multiplier in an economy increases with which one of the following?

(a) Increase in the cash reserve ratio

(b) Increase in the banking habit of the population

(c) Increase in the statutory liquidity ratio

(d) Increase in the population of the country

What is SOFR?

  • Secured Overnight Financing Rate (SOFR) is a secured interbank overnight interest rate.
  • It is a replacement for USD LIBOR (London Inter-bank Offered Rate) that may be phased out end-2021.
  • The overnight rate is generally the interest rate that large banks use to borrow and lend from one another in the overnight market.

Why SOFR?

  • Global regulators decided to move away from the Libor, a vital part of the financial system after it was revealed in 2012 that banks around the world manipulated it.
  • It also didn’t help that volume underlying the benchmark dried up.
  • U.K regulators set the deadline at 2021 for financial firms and investors to transition away from the Libor.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Digital Lending

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not Much

Mains level: Digital Lending and associated issue

The Reserve Bank of India (RBI) has constituted a working group on digital lending to study all aspects of digital lending activities in the regulated financial sector as well as by unregulated players.

NPAs are rising in India. And one may find some irritating ads and texts on our smartphones, which desperately wants to disburse easy loans (that too in a limited offer period)!

Digital Lending

  • Digital lending is the process of offering loans that are applied for, disbursed, and managed through digital channels, in which lenders use digitized data to inform credit decisions and build customer engagement.
  • It consists of lending through web platforms or mobile apps, by taking advantage of technology for authentication and credit assessment.

Why in news?

  • The move comes in the backdrop of the three borrowers in Telangana committing suicide over alleged harassment by personnel of such digital lenders.
  • There were many more complaining of being subjected to coercive methods after defaulting on repayments.

Why regulate Digital Lending?

  • Digital lending has the potential to make access to financial products and services more fair, efficient and inclusive.
  • From a peripheral supporting role a few years ago, FinTech-led innovation is now at the core of the design, pricing and delivery of financial products and services.
  • While penetration of digital methods in the financial sector is a welcome development, the benefits and certain downside risks are often interwoven.
  • A balanced approach needs to be followed so that the regulatory framework supports innovation while ensuring data security, privacy, confidentiality and consumer protection.

Risks associated

  • A growing number of unauthorized digital lending platforms and mobile applications are threats to consumers.
  • Such lenders charge excessive rates of interest and additional hidden charges.
  • They adopt unacceptable and high-handed recovery methods and in turn misuse agreements to access data on mobile phones of borrowers.

What will the working group do?

  • The RBI working group will evaluate digital lending activities and assess the penetration and standards of outsourced digital lending activities in RBI regulated entities.
  • They would thus identify the risks posed by unregulated digital lending to financial stability, regulated entities and consumers; and suggest regulatory changes to promote orderly growth of digital lending.
  • It will also recommend measures for expansion of specific regulatory or statutory perimeter and suggest the role of various regulatory and government agencies.
  • It will also recommend a robust fair practices code for digital lending players.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Economic recovery and its discontents

Note4Students

From UPSC perspective, the following things are important :

Prelims level: LTRO, Bonds

Mains level: Paper 30- Measures by the RBI to assure the Government bond holders

The article highlights the measures taken by the RBI in the recent MPC meeting to assure the buyers of the Government bonds and ensuring the policy rate transmission.

Dealing with the rate transmission issue and why it matters

  • The gap between the repo rate and the average lending rate of banks is at a record high.
  • So, the RBI and the MPC focused on improving rate transmission.
  • This gap can be broken up into two parts:
  • The first is the gap between the RBI-set repo rate and the rate at which the government of India borrows (the GSec yield).
  • It is also called the “term premium” can be influenced by the RBI’s actions.
  • The second is the gap between the GSec yield and the rate at which individuals or private firms borrow.
  • This gap reflects risk aversion in the financial system and a lack of capacity.
  • The RBI has avoided directly influencing the term premium, perhaps to maintain its credibility and independence, staying clear of accusations that it is financing the government’s fiscal deficit.
  • However, unless the rate at which the government borrows comes down borrowing costs for the whole economy will stay elevated.

Challenge of Balance-of-Payment surplus (i.e. excess dollars)

  • Over the past few months, the country’s foreign currency reserves have been growing at an unprecedented rapid pace.
  • This means that India is getting far more dollars than it needs. Three factors are responsible for this.
  • 1) Some short-term factors responsible are weak imports and a faster normalisation of exports.
  • 2) There have also been structural shifts in India’s economic policy which point to a persistent BoP surplus.
  • In addition to low energy prices, policies supporting Atmanirbhar Bharat mean lower imports and the push towards making India a participant in global value chains mean higher exports.
  • 3) At the same time, India’s capital account is being opened up: The special-category government of India bonds, for example.

Why BoP surplus is opportunity

  • When the excess dollar inflows turn into a deluge, as they have over the past six months, the supply of rupees in the domestic economy also becomes excessive.
  • If the RBI can direct this surplus into government bonds, it can maintain its independence and credibility, and at the same time achieve its target of rate transmission.

Measures by the RBI to assure the bond market

  • The buyers of government bonds need to feel reassured of not getting hurt by the volatility in bond prices.
  • When bond prices rise, the yields fall, and vice versa.
  • Banks parking trillions of rupees with the RBI at 3.35 per cent overnight would earn nearly 6 per cent if they bought government bonds.
  • That they did not was because they were afraid of the bond prices falling, which would offset the gains from higher rates.
  • The increase in the Hold-To-Maturity limits by the RBI  by one year to March 2022, has assured the banks that they need not fear booking interim losses if bond prices are volatile.
  • The announcement that the RBI would purchase state and central government bonds on the market (even if in small sizes) would provide further comfort.
  • The change in assessment of inflation should help buyers of government bonds take the risk.
  • Banks or other bond investors that refrained from purchasing government bonds because they felt the RBI would increase interest rates at some point to comply with its legal mandate, would be reassured by this clear communication.
  • The targeted refinancing operations (TLTRO) should help bring down borrowing rates in the targeted industries.

Conclusion

Economic challenges may persist for the foreseeable future. The economic scars of the last six months are likely to take time to heal. The RBI and the MPC, which have been proactive, creative and accommodative so far, may have to stay so for a while longer.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Priority Sector Lending (PSL)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: PSL

Mains level: PSL

The RBI has released a revised priority sector lending guidelines to augment funding to segments including start-ups and agriculture.

New Priority Sector Lending (PSL) guidelines

  • Bank finance of up to ₹50 crores to start-ups, loans to farmers both for installation of solar power plants for Solarization of grid-connected agriculture pumps and for setting up compressed biogas (CBG) plants have been included as fresh categories eligible for finance under the priority sector.
  • This has come to align it with emerging national priorities and bring a sharper focus on inclusive development, after having wide-ranging discussions with all stakeholders.
  • It will enable better credit penetration to credit deficient areas, increase the lending to small and marginal farmers and weaker sections, boost credit to renewable energy, and health infrastructure
  • The targets prescribed for ‘small and marginal farmers’ and ‘weaker sections’ are being increased in a phased manner.
  • Higher credit limit has been specified for farmer producer organisations (FPOs)/farmers producers companies (FPCs) undertaking farming with assured marketing of their produce at a pre-determined price.

Back2Basics: Priority Sector Lending

  • PSL is an important role given by the (RBI) to the banks for providing a specified portion of the bank lending to few specific sectors like agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low-income groups and weaker sections.
  • This is essentially meant for an all-round development of the economy as opposed to focusing only on the financial sector.
  • The broad categories of priority sector for all scheduled commercial banks are as under:
  1. Agriculture and Allied Activities (Direct and Indirect finance)
  2. Small Scale Industries (Direct and Indirect Finance)
  3. Small Business / Service Enterprises
  4. Micro Credit
  5. Education loans
  6. Housing loans

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

New umbrella entities (NUEs) for retail payments.

Note4Students

From UPSC perspective, the following things are important :

Mains level: Paper 3-NEU by RBI

Context

  • Last week the Reserve Bank of India (RBI) released a document setting out the framework it plans to adopt to authorize the establishment of new umbrella entities (NUEs) for retail payments.

What are NUEs

  • Once established, these newly authorized entities will be able to operate their own clearing and settlement systems.
  • establish new standards and technologies; and develop innovative new payment systems that enhance customer access, convenience and safety.
  • All NUEs will have to be interoperable with the National Payments Corporation of India (NPCI).
  • NPCI would also be allowed to set themselves up as for-profit entities, and they will themselves be able to participate in RBI’s payment and settlement systems.
  • The NPCI is at the epicentre of the digital payments in the country.

If NPCI is doing its job well, then why NUE?

  • Between the UPI, IMPS, Aadhaar-enabled payments, Bharat BillPay, and all the other payment systems that it manages, 48% of all electronic retail payments in the country pass through the NPCI infrastructure.
  • NPCI is the fulcrum around which everything digital revolves.
  • Perhaps RBI’s concern stems from having the operations of so much of the country’s payment system concentrated in one entity.

Are the concerns of RBI valid?

  • There is nothing wrong with having all digital transactions flow through a single entity—so long as that entity is neutral.
  • If RBI’s concern is technical, we could build sufficient redundancy into NPCI’s technical architecture to ensure that there is no single point of failure in the system.
  • Creating multiple umbrella entities is not the answer to this problem, as NUEs would be allowed to establish themselves as profit-oriented entities.
  • There is also the question of whether the trade-off is even worth it as replicating the NPCI infrastructure will require heavy investments to make participants in one NUE can seamlessly interact with those in every other.
  • Ensuring interoperability while still maintaining the security of the underlying infrastructure is going to be difficult and expensive.
  • There is the cost of the additional regulatory burden that RBI will have to shoulder, now that the banking-sector regulator will have to manage not just one but multiple umbrella entity.

Issues with NPCI

  • There would be consequences to letting NPCI only entity in handling the payment system.
  • Any sort of monopoly results in market inefficiencies.
  • Of we have just one umbrella regulator, we will never be sure if transaction costs are as low as they could be, or if the variety of product offerings available to us could be better.
  • Problem is that the NPCI is expected to both manage the digital payments industry as well as come up with the frameworks necessary to foster innovation.
  • When NPCI had just small products in its portfolio it was able to perform both functions efficiently.
  • The effort of just keeping the system working seems to be taking a toll on NPCI’s ability to develop the protocols and standards that are needed to encourage innovation in this boom sector.

What is the solution to issues faced by NPCI

  • One possible solution might be to create a separate and independent standards-setting body.
  • Such body would come up with the protocols and standards required to foster innovation in the digital payments space.
  • This is how most successful digital infrastructure systems work. Take the World Wide Web, for example.
  •  Any new standard that this body creates will have to first be approved by the NPCI, but then it can be rolled out throughout the digital payments ecosystem.

Consider the question “Examine the role played by the NPCI in revolutionising the payment system in India.”

Conclusion

By establishing a neutral and independent standards-setting body, we can make sure that the system as a whole in our country evolves in the best traditions of digital infrastructure adopted anywhere in the world.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

The idea of Central Bank Digital Currency in India

Note4Students

From UPSC perspective, the following things are important :

Prelims level: NUE by the RBI

Mains level: Paper 3- Digital currency by the central bank and its advantages

The article discusses the idea of digital currency supported by the RBI and its advantages.

Purpose of NUE

  • RBI recently released the framework for the establishment of a new umbrella entity (NUE) for retail payments.
  • NUE would help reduce payments concentration risk with Unified Payments Interface (UPI) facilitating over 1.5 bn transactions a month.
  • Given the sticky adoption and only a few payments apps dominating the UPI market, RBI intends to create a parallel retail system.

5 requirements payment systems should fulfil

  • 1) The payments system should reduce the cost and time for government support to reach unbanked and underbanked people.
  • 2) It should ensure ease of access to credit for small and medium businesses.
  • 3) Improve the effectiveness of the implementation of monetary policy.
  • 4) The new payment system should effectively counter risk from unregulated new digital currencies like Bitcoin.
  • 5) It should discourage money laundering and tax evasion.

CBDC: Solution to the above 5 requirements

  • CBDC is the digital form of fiat money, a digital equivalent of banknotes and coins.
  • A Central Bank Digital Currency (CBDC) could potentially solve the above problems.
  • Retail CBDCs can be issued directly by the central bank to people without going through traditional banks.
  • Individuals would have CBDC accounts directly on the central bank core ledger.
  • CBDC can reduce the cost and time for government support to reach people during desperate times (like pandemic).
  • CBDC can also enable many financial entities to settle directly with RBI.
  • In the current set up only a few large banks can settle directly with RBI.
  • With a digital currency, the settlement can be instantaneous and, as a result, more payments services providers like NBFCs could connect with RBI, thereby, reducing credit and liquidity risk.
  • CBDC lending would build MSMEs history and make further lending easier.
  • For India to be a $5 tn economy, businesses need credit, and that can happen when we have more banks.
  • India had 97 banks in 1947; today we are still at 95!
  • Interest bearing CBDCs can also improve monetary policy effectiveness by enabling real-time pass-through of the policy rate to the lending markets.
  • CBDCs can also allow for direct deposits into accounts of low-income households, senior citizens dependent on pensions and help cushion their purchasing power from the low-level interest rates during the times of economic downturn.
  • CBDC can thwart some competition against privately issued foreign currency-denominated digital currencies.

Roles and responsibility of RBI with respect to CBDC

  • In terms of managing roles and responsibilities, RBI would only hold the accounts and implement monetary policies as it does now.
  • Fintech companies can become the channel for retail CBDC transmission and manage client relationships.
  • Fintechs can complement the commercial banks and can draw small businesses/poor households into the formal economy.
  • These companies could leverage their data to estimate customers’ creditworthiness and share their findings to banks for more efficient allocation of credit.

Consider the question “A digital currency backed by the central bank could transform the retail payment landscape in India. Discuss.”

Conclusion

India has been at the forefront of the fintech revolution, and other developed countries have been following its path. While the world watches the melee between the Greenback and the Renminbi, it is time India also lays the foundation for a strong currency. CBDC may just be one of the ways to do it.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s Positive Pay system

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Positive Pay Mechanism

Mains level: Not Much

The new ‘Positive Pay’ mechanism was recently introduced by the Reserve Bank of India (RBI).

Try this PYQ:

With reference to digital payments, consider the following statements:

  1. BHIM app allows the user to transfer money to anyone with a UPI-enabled bank account.
  2. While a chip-pin debit card has four factors authentication, BHIM app has only two factors of authentication.

Which of the statements given above is/are correct? (CSP 2018)

a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2

What is the move?

  • Issuers will be able to send all details to their bank, thereby ensuring faster clearance of cheques above Rs 50,000.
  • All cheques will be processed as per the information sent by the account holder at the time of issuance of cheques.
  • This will cover approximately 20 per cent of transactions by volume and 80 per cent by value.
  • It will make cheque payments safer and reduces instances of frauds.

What is Positive Pay Mechanism?

  • Positive Pay is a fraud detection tool adopted by banks to protect customers against forged, altered or counterfeit cheques.
  • It crosses verifies all details of the cheque issued before funds are encashed by the beneficiary.
  • In case of a mismatch, the cheque is sent back to the issuer for examination.
  • By following such a system, a bank knows of a cheque being drawn by the customer even before it is deposited by the beneficiary into his/her account.

How does the mechanism work?

  • Under Positive Pay feature, the issuer will first share the details of the issued cheque like cheque number, date, name of the payee, account number, amount and the likes through his/her net banking account.
  • Along with this, an image of the front and reverse side of the cheque is also required to be shared, before handing it over to the beneficiary.
  • When the beneficiary submits the cheque for encashment, the details are compared with those provided to the bank through Positive Pay.
  • If the details match, the cheque is honoured. However, in the case of mismatch, the cheque is referred to the issuer.
  • In this way, any cheque where any sort of fraud has happened cannot be cleared at all and hence, a depositor’s money can be protected.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

How are inflation rate and interest rate linked?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Monetary Policy tools

Mains level: Not Much

The Monetary Policy Committee of the RBI has decided to keep the benchmark interest rates of the economy unchanged.

Try this PYQ:

Q.Which one of the following is not the most likely measures the Government/RBI takes to stop the slide of Indian rupee? (CSP 2019)

(a) Curbing imports of non-essential goods and promoting exports

(b) Encouraging Indian borrowers to issue rupee-denominated Masala Bonds

(c) Easing conditions relating to external commercial borrowing

(d) Following an expansionary monetary policy

What is the link between growth, inflation and interest rates?

  • In a fast-growing economy, incomes go up quickly and more and more people have the money to buy the existing bunch of goods.
  • As more and more money chases the existing set of goods, prices of such goods rise.
  • In other words, inflation (which is nothing but the rate of increase in prices) spikes.

How interest rates dominate?

  • To contain inflation, a country’s central bank typically increases the interest rates in the economy.
  • By doing so, it incentivizes people to spend less and save more because saving becomes more profitable as interest rates go up.
  • As more and more people choose to save, money is sucked out of the market and inflation rate moderates.

What happens when growth rate decelerates or contracts?

  • When growth contracts or when its growth rate decelerates, people’s incomes also get hit.
  • As a result, less and less money is chasing the same quantity of goods.
  • These results in either the inflation rate decline.
  • In such situations, a central bank cuts down the interest rates so as to incentivise spending and by that route boost economic activity in the economy.
  • Lower interest rates imply that it is less profitable to keep one’s money in the bank or any similar saving instrument.
  • As a result, more and more money comes into the market, thus boosting growth and inflation.

Why has RBI not raised interest rates this quarter?

  • RBI is facing an odd situation at present: GDP is contracting even as inflation is rising.
  • This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other.
  • As a result, both things are happening — falling growth and rising inflation.
  • It is true that for containing inflation, RBI should raise interest rates.
  • And under normal circumstances, it would have done just that. But raising interest rates at this stage would be catastrophic for India’s GDP growth.

Risks of altering interest rates

  • If the RBI cuts the interest rate, it may be fuelling retail inflation further. It must be remembered that inflation hits the poor the hardest.
  • So, the RBI has chosen to do what many expected it to do: stay put and waits for another couple of months to figure out how growth and inflation are shaping up.

Back2Basics: Monetary Policy Committee (MPC)

  • The RBI Act, 1934 (RBI Act) was amended by the Finance Act, 2016,  to provide for a statutory and institutionalized framework for an MPC, for maintaining price stability, while keeping in mind the objective of growth.
  • The MPC is entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.
  • The meetings of the MPC are held at least 4 times a year and it publishes its decisions after each such meeting.
  • As per the provisions of the RBI Act, out of the six members of the committee, three members are from the RBI and the other three Members of MPC are appointed by the Central Government.
  • Governor of the RBI is ex officio Chairman of the committee.

Economics | Monetary Policy Explained with Examples

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI signs $400 mn currency swap facility for Sri Lanka

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Currency Swap

Mains level: Cryptocurrency and its feasiblity

The RBI has agreed to a $400 million currency swap facility for Sri Lanka till November 2022.

Practice question for mains:

Q. What are Currency Swaps? Discuss the efficacy of Currency Swap Agreements for liberalizing bilateral trade.

Why such move by RBI?

  • The RBI’s action follows a recent bilateral ‘technical discussion’ on rescheduling Colombo’s outstanding debt repayment to India.
  • Following the outbreak of COVID-19 in the region, India had proposed a virtual meeting to discuss the request. Sri Lanka owes $960 million to India.
  • In turn, Sri Lanka would facilitate, protect and promote a liberal ecosystem for Indian investors.

What are Currency Swaps?

  • A currency swap, also known as a cross-currency swap, is an off-balance sheet transaction in which two parties exchange principal and interest in different currencies.
  • Currency swaps are used to obtain foreign currency loans at a better interest rate than could be got by borrowing directly in a foreign market.

How does it work?

  • In a swap arrangement, RBI would provide dollars to a Lankan central bank, which, at the same time, provides the equivalent funds in its currency to the RBI, based on the market exchange rate at the time of the transaction.
  • The parties agree to swap back these quantities of their two currencies at a specified date in the future, which could be the next day or even three months later, using the same exchange rate as in the first transaction.
  • These swap operations carry no exchange rate or other market risks, as transaction terms are set in advance.

Why does one need dollars?

  • FPIs investors look for safer investments but the current global uncertainty over COVID outbreak has led to a shortfall everywhere in the global markets.
  • This has pulled down foreign exchange reserves of many small and developing countries.
  • This means that the government and the RBI cannot lower their guard on the management of the economy and the external account.

Benefits of currency swap

  • The absence of an exchange rate risk is the major benefit of such a facility.
  • This facility provides the flexibility to use these reserves at any time in order to maintain an appropriate level of balance of payments or short-term liquidity.
  • Swaps agreements between governments also have supplementary objectives like the promotion of bilateral trade, maintaining the value of foreign exchange reserves with the central bank and ensuring financial stability (protecting the health of the banking system).

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Governance of the commercial banks

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Companies Act 2013

Mains level: Paper 3- Governance issue in the banks

This article discusses the nitty-gritty of the recently released discussion paper by the RBI on governance. Governance in the commercial bank has been in the news following the failures of some banks.

Discussion paper by RBI

  • Recently RBI released a discussion paper on ‘Governance in Commercial Banks in India’.
  • Recently there have been high-profile instances involving governance failures in certain banks.
  • These instances have called into question the adequacy of the existing legal regime for ensuring good governance in commercial banks.
  • Internationally, the question of governance norms in banks is treated differently given the complex nature of functions performed by banks in comparison to other businesses.
  • Functions of the banks make them critical for allocation of resources in the economy, protection of consumer interests and maintenance of financial stability.

Objectives of the discussion paper

  • The stated objective of the discussion paper is to align the current regulatory framework on bank governance with global best practices.
  • Best practices include the guidelines issued by the Basel Committee on Banking Supervision and the Financial Stability Board.

Current regulatory framework

  • To this end, RBI adopts international standards for bank governance into the general corporate governance framework in India.
  • This general governance framework comprises the Companies Act, 2013, and the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Requirements, 2015.
  • These governance norms focus on the responsibilities of the board of directors, board structure and practices.
  • And it also includes aspects of risk management, internal audit, compliance, whistle-blowing, vigilance, disclosure and transparency.

Issue of connection between management and owner

  • RBI also constituted an internal working group to review the extant regulatory guidelines relating to ownership and control in private sector banks.
  • This group is expected to submit its report by September 30, 2020.
  • But the assumption that deeper connections between the management and the owners necessarily lead to mismanagement needs to evaluated carefully and recalibrated to ensure balanced reforms.
  • The governance risks attributable to such connections might be relevant for government-owned banks as well.

Key recommendations in the paper

  • (1) The majority of a commercial bank’s board must comprise of independent directors.
  • This is a standard higher than that prescribed under the Companies Act and the SEBI Regulations.
  • (2) The chairperson of the board must be an independent director.
  • (3) Chairpersons of crucial board committees (the audit committee, the risk management committee and the nomination and remuneration committee) must be independent directors who are not chairpersons of any other board committee.
  • (4) The tenures of non-promoter CEOs and WTDs should be limited to 15 years.

Way forward

  • In order to make the reform effective, the appointment process for independent directors also needs to be re-evaluated to limit the role of controlling-shareholders.
  • The liability regime for directors on the boards of banking companies should also be revisited to balance the rights and liabilities of the directors.
  • The efficacy of implementation of norms as prescribed will depend on adequate enforcement.
  • The findings of the report of the working group have to be considered to formulate a comprehensive and effective governance framework for commercial banking in India.

Consider the question “Given the complex nature of functions performed by the banks in comparison to other businesses subjecting them to stricter norms of governance is necessary. In light of this examine the adequacy of existing governance norms and suggest ways to improve them.”

Conclusion

RBI must exercise caution to ensure that the reforms balance the interests of all the stakeholders and do not come at the cost of discouraging investments and entrepreneurship in the Indian banking industry.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Urban, multi-State cooperative banks to come under RBI supervision

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RRBs, Cooperative Banks

Mains level: RBI regulations of default bankers

To ensure that depositors are protected, the Centre has decided to bring all urban and multi-State cooperative banks under the direct supervision of the Reserve Bank of India (RBI).

Practice question for mains:

Q. What are Cooperative Banks? How are they regulated? Discuss their role in extending credit facilities in rural India.

What are Cooperative Banks?

  • A Co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank.
  • They are registered under the States Cooperative Societies Act.
  • They are also regulated by the Reserve Bank of India (RBI) and governed by the Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1955.

What is the present decision?

  • The urban cooperatives and multi-State cooperative banks have been brought under RBI supervision process, which is applicable to scheduled banks.
  • Currently, these banks come under dual regulation of the RBI and the Registrar of Co-operative Societies.

Why such a move?

  • The move to bring these urban and multi-State coop banks under the supervision of the RBI comes after several instances of fraud and serious financial irregularities.
  • The most recent was the major scam at the Punjab and Maharashtra Co-operative (PMC) Bank last year.
  • The RBI was forced to supersede the PMC Bank’s board and impose strict restrictions.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI should preserve its inflation credibility

Note4Students

From UPSC perspective, the following things are important :

Prelims level: MPC

Mains level: Paper 3- MPC and RBI actions which are inimical to mandate of MPC.

This article by Urjit Patel elaborates on the recent actions of the RBI which are likely to result in making the role of MPC redundant. Some of the moves cited are injection of liquidity by the RBI and reduction of reverse repo rate by the RBI. Implications such actions could have for the macroeconomic stability are also discussed.

Stimulus package after the 2008 financial crisis and problems created by it

  • Following the global financial crisis of 2007-08, India, like many other countries, embarked on a stimulus.
  • The pump-priming did not end too well.
  • Inflation and bad loans: By 2013, India crossed or approached double-digit figures in inflation and the national fiscal deficit, in addition to looming bad loans.
  • Taper tantrum: In summer 2013, when the Federal Reserve indicated a possible reversal of its ultra-accommodative policy, macroeconomic parameters for India were so weak that it got caught up in the “taper tantrum” and experienced external sector fragility.

Inflation targeting and the role of MPC

  • While fiscal excesses and financial sector stress remain issues today, India has improved significantly on at least one dimension — namely, inflation — which has also stabilised the external sector.
  • How was this beneficial progress achieved?
  • Starting in September 2013, the Reserve Bank of India (RBI) initiated an effort to build credibility with domestic savers and international investors on maintaining inflation at prudent levels.
  • Three years thereafter, the RBI Act was amended to put in place a flexible inflation targeting framework.
  • A Monetary Policy Committee (MPC), comprising of RBI representatives and external members appointed by the Government of India, was enjoined with the legal mandate of managing the policy (repo) rate.
  • MPC was mandated to keep consumer price inflation at a target level of 4 per cent, while keeping in mind economic growth.

Assessment of MPC’s performance

  • By objective measures, the MPC framework until recently worked rather well.
  • It lent transparency and democratic accountability to the process of interest-rate setting.
  • Combined with efforts on managing food inflation, it has brought inflation closer to the target.
  • It has contributed to tempering household inflation expectations.
  • It has kept borrowing costs in the economy at reasonable levels in spite of the high level of government borrowing and several other distortions.
  • Appreciation by the rating agencies: Indeed, rating agencies and multilateral institutions repeatedly mention the MPC and the inflation targeting framework as a landmark structural reform towards sound macroeconomic management.

Latest monetary actions by RBI that reduced MPC’s role

  • Since last year, a series of monetary actions by the RBI have left the MPC’s decision on the policy rate partly redundant, diluted the accountable process of monetary decision-making.
  • This has put at stake the sanctity of the MPC framework.
  • With a stated intention to improve the transmission of monetary policy to households and corporations, the RBI has pumped unprecedented levels of money (close to Rs 7 trillion) into the banking system.
  • It has done so mostly by purchasing government bonds but partly also by purchasing dollars.
  • No desired results: Given impaired financial sector balance-sheets, transmission to economic growth has been at best muted; liquidity is no silver bullet to durably address financial sector stress.
  • The primary effect of excessive liquidity has, instead, been to monetise the government’s expenditures and keep its borrowing costs low.
  • With its declared aim not being met satisfactorily, the RBI has doubled down on liquidity supply, with the same outcome.
  • An important casualty has been the MPC framework.
  • Contradictory actions: At times, even when the MPC has kept the policy rate unchanged, the RBI has injected yet more liquidity to move medium-term interest rates down.
  • The two actions have been noted to be in direct contradiction of each other.
  • If the objective is to move medium-term rates, why not build consensus within the MPC to cut the policy rate more aggressively and communicate the rationale?
  • Change in reverse repo by the RBI: Further, given the enormous liquidity glut, every night banks park liquidity with the RBI at a (reverse repo) rate lower than the policy rate and which is not set by the MPC; nevertheless, this rate used to be changed only as part of the MPC Resolution.
  • Lately, the RBI has moved reverse repo rate progressively lower than the policy rate; recently.
  • It has done so outside of the MPC meeting cycle and not as part of the MPC Resolution.
  • There are straightforward tools in liquidity management to ensure that in surplus conditions also, the central bank transacts with banks at the policy rate — technically, by switching from “deficit” to “floor” system of liquidity management.
  • Such a switch is routinely adopted by central banks when they provide excess liquidity; the RBI has chosen not to do so.

What are the implications?

  • The net effect is that market interest rates are being increasingly controlled by the RBI rather than the MPC.
  • Indeed, there is a proposal that the rate at which the RBI absorbs liquidity be still lower, likely divorced from the policy rate set by the MPC.
  • The spirit of the MPC framework enshrined in the RBI Act is being violated.
  • It is unclear how the MPC can be expected to satisfy its legal mandate if what it seeks to achieve via the setting of the policy rate is in conflict with, or compromised by, the RBI’s liquidity management.
  • These developments have the potential to pose risks for India’s macroeconomic stability going forward.
  • The implicit monetisation of fiscal expenditures through government bond purchases by the RBI in the secondary market has postponed the recognition of the untenable fiscal reality.
  • The delay has meant the government has had limited policy space since the onset of COVID.
  • Supply-chain disruptions due to measures taken to contain the pandemic raise the possibility of cost-push inflationary pressures, especially given the excessively easy fiscal and monetary conditions.
  • This can abruptly raise economy-wide borrowing rates, inflict losses on banks, and imperil financial stability.
  • If the gains in inflation credibility built by the MPC framework are dissipated by ineffective policies and operations, both household and investor expectations for inflation in India could unhinge.
  • Worse, it could instigate turmoil in the external sector.
  • Excessively low bank deposit rates may induce some non-resident deposits to exit the country.

A question based on the issue of RBI’s action and its implication for MPC and overall economy can be asked by the UPSC, for ex- “The MPC framework has performed well in delivering on its mandate. Yet, there were some actions by the RBI recently which could be perceived as inimical to the functions of the MPC. Discuss.”

Conclusion

In a highly unpredictable time such as this, the RBI should preserve its inflation credibility. The decision on monetary policy actions based on voting by committee members, provision of inflation and growth forecasts in the resolution statement, and coordination of rate-setting and liquidity management, need to be adhered to.


Back2Basics: What is MPC?

  • The Reserve Bank of India Act, 1934 (RBI Act) was amended by the Finance Act, 2016,  to provide for a statutory and institutionalised framework for a Monetary Policy Committee, for maintaining price stability, while keeping in mind the objective of growth.
  • The Monetary Policy Committee is entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level.
  • The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.
  • As per the provisions of the RBI Act, out of the six Members of Monetary Policy Committee, three Members are from the RBI and the other three Members of MPC are appointed by the Central Government.
  • Governor of the RBI is ex officio Chairman of the committee.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Time for govt, RBI to rethink bank architecture

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Various policy rates of the RBI.

Mains level: Paper 3- What were the measures announced by the RBI to deal with the impact of Covid-19 on economy and how far were the measure successful in achieving the intended goals?

To deal with the damage inflicted by the corona crisis on the economy, both the RBI and the government are planning various monetary and fiscal measures. In its latest measures, the RBI has further reduced the reverse repo rate. This article discusses the impact of these measures and explains why the first round of measures failed in achieving the desired result.

What was announced in the second round of policy measures by the RBI?

  • RBI reduces the interest on money banks keep in the central bank (reverse repo down by 25 basis points).
  • RBI gives ₹50,000 crores to banks through targeted long-term repo operations or TLTRO 2.
  • And another ₹50,000 crores to Small Industries Development Bank of India (Sidbi) and National Bank for Agriculture and Rural Development (Nabard) to lend to microfinance institutions (MFIs) and non-banking financial companies (NBFCs).

Banks not transmitting the money

  • Banks globally have a problem.
  • They are not transmitting the money that central banks are providing to businesses that need the money.
  • Imagine that the world has been put into a business coma as we wait for the pandemic to recede.
  • Money to pay rents, interest and salaries is needed by the business to stay alive during this period and banks are showing reluctance to step in.
  • Firms and tiny entrepreneurs need to borrow to stay afloat.
  • Banks typically lend to the larger part of the market and NBFCs and MFIs to the rest—they provide the last mile that banks do not.

Measures by the RBI to increase the money supply in the market

  • The US Fed buying bonds directly: The US Federal Reserve has taken to buying corporate bonds directly rather than through banks.
  • RBI has not gone that far, but is using its firepower to nudge banks to lend to those who are credit-worthy and who desperately need the money.
  • It has done two things to facilitate this.

What reduction in Reverse Repo rate by the RBI means?

  • What is reverse repo rate? This is the rate at which banks lend to the central bank—they keep their surplus money with the RBI and get some interest on it.
  • Banks borrow from RBI at the repo rate, which is 4.4% right now.
  • A few weeks ago, the central bank had reduced the reverse repo by a larger percentage than the repo to decrease the incentive to banks to keep money with RBI.
  • But that had a limited impact as on 15 April, banks still had almost ₹7 trillion with the RBI under this window.
  • In the second round, RBI has cut the reverse repo by another 25 basis points to 3.75% to increase the difference between the borrowing rate and the lending rate.
  • What would be the impact of the second reduction in the reverse repo? The RBI is hoping that this would make banks lend to firms, rather than keeping their money safe with RBI.
  • The difference between the rate of borrowing and lending is now 65 basis points.

An issue of monetary policy transmission is a recurring one. The RBI always try to ensure the transmission but there are several factor that prevent it. Make note of these factors.

Risk aversion of the banks

  • Banks are displaying deep risk aversion—the desire to keep their capital safe rather than risk investing in investment-worthy bonds.
  • The first round of money put into the system through TLTRO 1.0, brought ₹1 trillion.
  • TLTRO is long-term (one-to-three years) funding to banks at the repo rate or a short-term rate.
  • TLTRO money didn’t reach small and medium firms: Banks took the cheap loan and lent to high-rated public sector units (PSUs) and AA-plus firms—essentially entities who had enough liquidity.
  • The money did not find its way to smaller and medium firms, NBFCs and MFIs—entities that actually reach the last mile.
  • RBI has put another ₹50,000 crores as part of TLTRO 2.0.
  • Banks can only get this money if they lend to NBFCs and MFIs.
  • For A and A-minus (these are still investment-worthy) bonds issued by firms in these sectors, banks stand to get a return of between 10-14%.
  • Banks are borrowing at 4.4% and have the option to lend at a multiplier.
  • That is the incentive given by the RBI to get money down the pipeline.
  • Banks stand to lose 65 basis points if they seek the safety of money with the RBI or stand to gain almost 6-10 percentage points in interest if they lend.
  • It remains to be seen if banks take this nudge and begin lending to lower than the highest safety bonds.

Refinance to three institutions

  • Another ₹50,000 crores is being provided as a refinance to three institutions-Sidbi, Nabard and National Housing Bank.
  • These banks reach the small-scale firms, rural sector, housing finance firms, NBFCs and MFIs.
  • Again, this should help money reach the last mile.
  • Clearly, there is too much competition at the top end of the market—everybody wants the safe paper and deals.

The UPSC could ask a direct question with reference to the issue of policy transmission and how it is a serious challenge in crisis such as Covid -19. So, following are some suggestions to deal with this issue.

Way forward

  • Rethink the bank architecture: With transmission, or the liquidity given by the central bank not going down the line, maybe this is a good time for the government and the RBI to rethink its bank architecture.
  • Develop bond a corporate bond market: There is very little action at the middle and lower end of the market. The development of a robust corporate bond market will help.
  • Early alarm system: The setting up of an early alarm system as proposed by the Financial Resolution and Deposit Insurance (FRDI) Bill to prevent a financial firm failure that takes the whole system down would be a step in the right direction.

Back2Basics: What is the transmission of monetary policy?

  • Monetary transmission refers to the process by which a central bank’s monetary policy signals (like repo rate) are passed on, through the financial system to influence the businesses and households.
  • There are many monetary policy signals by the RBI; the most powerful one is the repo rate.
  • When repo rate is changed, it brings changes in the overall interest rate in the economy as well.
  • As a result of a decrease in repo rate, the interest rate on loans by banks also changes and this encourages consumption and investment activities of businesses and households.
  • In an economy, both consumption and investment are often financed by borrowings from banks.
  • As the repo rate brings changes in market interest rate, the repo rate channel is often referred to as interest rate channel of monetary transmission.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

OBICUS Survey by RBI

Note4Students

From UPSC perspective, the following things are important :

Prelims level: OBICUS

Mains level: Not Much

The Reserve Bank of India has launched the latest round of quarterly order books, inventories and capacity utilization survey (OBICUS) of the manufacturing sector.

OBICUS is something new than we often get to hear from RBI…. Most recent was Ways and Means Advances. We can expect prelims question like- “Order books, inventories and capacity utilization survey (OBICUS) of the manufacturing sector is held by” – with options like NSSO, Labour Bureau etc.

OBICUS

  • OBICUS survey on the manufacturing sector is published quarterly by the RBI since March 2008.
  • It provides an insight into the demand conditions faced by the Indian manufacturing sector.
  • It covers over 2500 public and private limited companies in the manufacturing sector.
  • The company-level data collected during the survey are treated as confidential and never disclosed.

Items included in OBICUS

  • The information collected in the survey includes quantitative data on new orders received during the reference quarter, backlog of orders, pending orders, total inventories with a breakup between work-in-progress (WiP) and finished goods (FG) inventories and item-wise production.

Significance of OBICUS

  • The survey provides valuable input for monetary policy formulation.
  • It represents the movements in actual data on order books, inventory levels of raw materials and finished goods and capacity utilization.
  • These are considered as important indicators to measure economic activity, inflationary pressures and the overall business cycle.
  • The survey also gives out the ratio of total inventories to sales and ratio of raw material (RM) and finished goods (FG) inventories to sales in percentages.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Counter-cyclical Capital Buffers (CCyB)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Countercyclical Capital Buffers (CCyB)

Mains level: Various minimum capital requirements measures

The RBI has announced that banks need not activate countercyclical capital buffers (CCyB) amid slowdown due to COVID-19 outbreak.

What is Countercyclical Capital Buffer (CCyB)?

  • A capital buffer is a mandatory capital that financial institutions are required to hold in addition to other minimum capital requirements.
  • CCyB is the capital to be kept by a bank to meet business cycle related risks. It is aimed to protect the banking sector against losses from changes in economic conditions.
  • Banks may face difficulties in phases like recession when the loan amount doesn’t return.
  • To meet such situations, banks should have own additional capital. This is an important theme of the Basel III norms.

CCyB framework in India

  • The framework on CCyB was put in place by the RBI in terms of guidelines issued in 2015 wherein it was advised that the CCyB would be activated as and when the circumstances warranted.
  • The framework envisages the credit-to-GDP gap as the main indicator, which is used in conjunction with other supplementary indicators.
  • It requires banks to build up a buffer of capital in good times, which may be used to maintain flow of credit to the real sector in difficult times.
  • The buffer was also meant to restrict the banking sector from indiscriminate lending in the periods of excess credit growth, which have often been associated with the building up of system-wide risk.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Ways and Means Advances (WMA)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: WMA

Mains level: Tools for countering cash-flow mismatches

 

The RBI has raised the Ways and Means Advances, or WMA, limit by 30% for all States and UTs to enable them to tide over the crisis caused by COVID-19 outbreak.

What are Ways and Means Advances?

  • The RBI gives temporary loan facilities to the centre and state governments as a banker to the government.  This temporary loan facility is called WMA.
  • It is a mechanism to provide to States to help them tide over temporary mismatches in the cash flow of their receipts and payments.
  • It was introduced on April 1, 1997, after putting an end to the four-decade-old system of adhoc (temporary) Treasury Bills to finance the Central Government deficit.
  • Under Section 17(5) of RBI Act, 1934, the RBI provides Ways and Means Advances (WMA) to the central and State/UT governments.

How is WMA availed?

  • This facility can be availed by the government if it needs immediate cash from the RBI.
  • The WMA is to be vacated after 90 days.
  • The interest rate for WMA is currently charged at the repo rate.
  • The limits for WMA are mutually decided by the RBI and the Government of India.

Types of WMA

There are two types of WMA — (1) Normal and  (2) Special :

  • Special WMA or Special Drawing Facility is provided against the collateral of the government securities held by the state.
  • After the state has exhausted the limit of SDF, it gets normal WMA. The interest rate for SDF is one percentage point less than the repo rate.
  • The number of loans under normal WMA is based on a three-year average of actual revenue and capital expenditure of the state.

Back2Basics

How the govt. meets temporary cash needs?

The fund deficit or cash-flow mismatches of the Government are largely managed through:

  1. Issuance of Treasury Bills
  2. Getting temporary loans from the RBI called Ways and Means Advances (WMA) and
  3. Issuance of Cash Management Bills (CMBs)
  • Treasury Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park their short term surplus funds while reducing their market risk.
  • CMBs are short term bills issued by the central government to meet its immediate cash needs. The bills are issued by the RBI on behalf of the government having a maturity of less than 90 days.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Fully Accessible Route (FAR)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Voluntary Retention Route (VRR), Fully Accessible Route (FAR)

Mains level: Not Much

The Reserve Bank of India (RBI) has introduced a separate channel, namely ‘Fully Accessible Route’ (FAR), to enable non-residents to invest in specified government bonds with effect from April 1.

Fully Accessible Route (FAR)

  • The move follows the Union Budget announcement that certain specified categories of government bonds would be opened fully for non-resident investors without any restrictions.
  • Under FAR, eligible investors can invest in specified government securities without being subject to any investment ceilings.
  • This scheme shall operate along with the two existing routes, viz., the Medium Term Framework (MTF) and the Voluntary Retention Route (VRR).

Benefits

  • This will substantially ease access of non-residents to Indian government securities markets and facilitate inclusion in global bond indices.
  • This would facilitate inflow of stable foreign investment in government bonds.

Back2Basics

Voluntary Retention Route (VRR)

  1. RBI had announced a separate scheme called VRR to encourage Foreign Portfolio Investors (FPIs) to undertake long-term investments in Indian debt markets.
  2. Under this scheme, FPIs have been given greater operational flexibility in terms of instrument choices besides exemptions from certain regulatory requirements.
  3. The details are as under:
  • The aggregate investment limit shall be ₹ 40,000 crores for VRR-Govt and ₹ 35,000 crores for VRR-Corp.
  • The minimum retention period shall be three years. During this period, FPIs shall maintain a minimum of 75% of the allocated amount in India.
  • Investment limits shall be available on tap for investments and shall be allotted by Clearing Corporation of India Ltd. (CCIL) on ‘first come first served’ basis.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Moratorium Option for payment of installments

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Moratorium Option

Mains level: Not Much

The RBI has permitted banks to allow moratorium of three months on payment of instalments in respect of all loans including home, car and personal loan among others.

What exactly this moratorium means?

  • Both the loan principal and interest are covered under the moratorium. This applies to all loans outstanding on March 1.
  • We must note that this is a postponement, not a waiver.
  • RBI’s wordings clearly say that the tenor for term loans across the board may be shifted by three months. This essentially means the loan will end 3 months later than was originally slated.
  • Essentially, it means that payees won’t be treated as a defaulter even if you don’t pay your EMI till May 2020, and your CIBIL score won’t be affected.
  • This moratorium period will not come free, and since the interest will continue to accrue on the outstanding portion of the loan during the moratorium period, it may increase the customers’ burden significantly.

The installments include:

  1. principal and/or interest components;
  2. bullet repayments;
  3. Equated Monthly installments;
  4. credit card dues

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Will RBI’s big-bang monetary easing work?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Not much.

Mains level: Paper 3- Why pumping more money into the economy at such point is unlikely to kickstart it?

Context

On Tuesday, the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) convened for an emergency meeting, ahead of schedule, to discuss its response to the economic challenges posed by the Covid-19 outbreak.

Bond market reaction to the RBI announcement

  • The MPC deliberated for three full days, but its decision would most probably have been sealed right at the onset.
  • For that day, the Indian bond market saw no trades in the first twenty minutes.
  • Fear and uncertainty in the market: The gap between the asking price and bids was so wide that the first trade for the day took place at 9:33 am. Gripped by uncertainty and fear about the future following the outbreak, the market had frozen.

Measures by the RBI

  • Injecting the liquidity of Rs. 3.74 trillion: Responding to the market signal, the RBI rolled out a slew of measures from its armoury that will release liquidity of up to ₹3.74 trillion, or nearly 2% of gross domestic product, in the financial system.
  • This will facilitate the market’s orderly functioning.
  • Condition on LTRO-created-liquidity: In particular, the condition that the liquidity created through the Long Term Repo Operations (LTRO) tool must only be deployed in corporate debt securities was a direct response to the disruption in the markets seeing heavy sell-offs in the midst of thin trading volumes.
  • Comparison with measures by the Fed.: The US Federal Reserve, which has launched an unconventional asset sales programme for $4 trillion, has announced it will also directly buy corporate bonds to ease the tight market.
  • RBI has refrained from following suit, instead of passing the buck to banks via the conditional LTRO liquidity.
  • Banks are unlikely to step in to ease the tight corporate securities market.
  • Repo rate below the level seen in 2008: To combat the economic consequences of the Covid-19 pandemic, the MPC has dropped its policy interest rate by 75 basis points, taking it down to 4.4%, a multi-year low.
  • The rate is now lower than it was in April 2009, when the central bank had taken it down to 75%, responding to the global financial crisis.
  • In 2008, just four days ahead of a scheduled policy review, RBI had cut the policy repo rate by 1 percentage point, sending an extraordinarily strong signal.

How the challenge this time is different from the 2008 crisis?

  • The nature of the current economic challenge is a lot different.
  • Economy at standstill: The shock back then had depressed demand, but the economy had not been brought to a standstill as it has now, with resources, including labour and capacities idling.

Why the measures would not kickstart the economy

  • Effect of rate cut: When all economic activity has halted, and uncertainty about the future is soaring, there’s no way a rate cut—no matter how steep—can kickstart the economy.
  • Businesses cannot plan for the future and will not borrow.
  • Banks will hold on too, fearful of the risk of loans going bad.
  • As it is, even before Covid-19 struck, credit disbursement was sluggish.
  • Now, with a host of companies facing the threat of credit rating downgrades, the probability of lenders turning a little less risk-averse is even lower.
  • Who would be the beneficiary of the rate cut? The biggest beneficiary of RBI’s rate cut—which was bigger than market expectations—would be the government.
  • Reduced borrowing cost for the government: In one stroke, the MPC has altered the fiscal deficit calculation by reducing the government’s borrowing cost.
  • There will be savings on its outgo on interest payments for new and rollover borrowings.

Three-month moratorium and issue with it

  • RBI also permitted banks and non-bank financial institutions to grant a three-month moratorium on loan repayments and reclassification of stressed loans as non-performing assets (NPAs).
  • This will provide relief by cushioning cash flow pressures for firms and individuals when incomes and revenues have dropped sharply due to the lockdown.
  • The forbearance on downgrading these loans will prevent a sharp spike in NPA levels for banks and NBFCs.
  • There could be a sharp rise in the bad loans: The risk now is that a few quarters after the end of the moratorium there could be a sharp rise in bad loans.
  • It could give rise to the NPA problem: In that sense, it amounts to kicking the problem of a potential spike in NPAs down the road.
  • The problem of evergreening: On balance, it is the right call given the extraordinary challenge of the lockdown—provided a new cycle of evergreening of loans by banks is not allowed in a repeat of what happened in the aftermath of the global financial crisis.

Way forward

  • What more could RBI have done? Special credit windows for the worst-hit sectors like aviation, hotels and tourism may soon be required.

Conclusion

While prioritising financial stability is fine, the MPC’s inflation projection is puzzling. While refraining from providing estimates on growth and inflation, given that the spread, intensity and duration of Covid-19 remain uncertain, RBI said it expects food price pressures to soften going ahead on account of a blow to demand during the lockdown. The projection seems unreasonable when there are unprecedented supply-side bottlenecks.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Regulation of Payment Aggregators (PAs)

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Payment Aggregators

Mains level: Regulation of online payment systems in India

The Reserve Bank of India released guidelines for regulating payment aggregators (PAs) and payment gateways (PGs), nearly six months after it first proposed regulating these entities in a discussion paper.

Payment Aggregators (PAs)

  • PAs are entities that facilitate e-commerce sites and merchants to accept various payment instruments from the customers for the completion of their payment obligations.
  • PGs are entities that provide technology infrastructure to route and facilitate the processing of an online payment transaction without any involvement in the handling of funds.
  • With the new set of guidelines PAs and PGs such as Paytm, Pay Pal, Mobikwik, Razorpay, PayU, CCAvenue etc. will be regulated by RBI to ensure the safety of all our online transactions.

What are the new guidelines?

The new guidelines say that-

  • A payment aggregator (entities that facilitate e-commerce sites and merchants to accept various payment instruments) should be a company incorporated in India under the Companies Act, 1956 / 2013.
  • Non-bank entities offering payment aggregator services will have to apply for authorisation on or before June 30, 2021.
  • E-commerce marketplaces providing payment aggregator services will have to be separated from the marketplace business and they will have to apply for authorisation on or before June 30, 2021.
  • Pas existing today will have to achieve a net worth of ₹15 crore by March 31, 2021 and a net worth of ₹25 crore by the end of third financial year, which means or before March 31, 2023.
  • The net-worth of ₹25 crore shall be maintained at all times thereafter.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

What are Open Market Operations (OMOs) ?

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Various instruments of OMOs, OMOs

Mains level: Read the attached story

The Reserve Bank of India (RBI) has decided to infuse ₹10,000 crore liquidity in the banking system by buying government securities through open market operations (OMO).

What are Open Market Operations (OMOs)?

  • OMOs are conducted by the RBI by way of sale and purchase of G-Secs to and from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
  • When the RBI feels that there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity.
  • Similarly, when the liquidity conditions are tight, RBI may buy securities from the market, thereby releasing liquidity into the market.

How and in what form can government securities be held?

  • The public debt office (PDO) of RBI, acts as the registry and central depository for G-Secs.
  • They may be held by investors either as physical stock or in dematerialized (demat/electronic) form.
  • It is mandatory for all the RBI regulated entities to hold and transact in G-Secs only in dematerialized subsidiary general ledger or SGL form.

Types:

i) Physical form

  • G-Secs may be held in the form of stock certificates. A stock certificate is registered in the books of PDO.
  • Ownership in stock certificates cannot be transferred by way of endorsement and delivery.
  • They are transferred by executing a transfer form as the ownership and transfer details are recorded in the books of PDO.
  • The transfer of a stock certificate is final and valid only when the same is registered in the books of PDO.

ii) Demat form:

  • Holding G-Secs in the electronic or scripless form is the safest and the most convenient alternative as it eliminates the problems relating to their custody, viz., loss of security.
  • Besides, transfers and servicing of securities in electronic form is hassle free.

How are the G-Secs issued?

  • G-Secs are issued through auctions conducted by the RBI.
  • Auctions are conducted on the electronic platform called the E-Kuber, the Core Banking Solution (CBS) platform of RBI.
  • The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the range of the tenor of securities and the period during which auctions will be held.
  • The RBI conducts auctions usually every Wednesday to issue T-bills (Treasury Bills) of 91-day, 182-day and 364-day tenors.
  • Settlement for the T-bills auctioned is made on T+1 day i.e. on a working day following the trading day. Like T-bills, CMBs are also issued at a discount and redeemed at face value on maturity.
  • The tenor, notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The tenors of CMBs are generally less than 91 days.

What is meant by repurchase (buyback) of G-Secs?

  • Repurchase (buyback) of G-Secs is a process whereby the central government and state governments buy back their existing securities, by redeeming them prematurely, from the holders.
  • The objectives of buyback can be the reduction of cost (by buying back high coupon securities), reduction in the number of outstanding securities and improving liquidity in the G-Secs market (by buying back illiquid securities) and infusion of liquidity in the system.
  • The repurchase is also undertaken for effective cash management by utilising the surplus cash balances.
  • The state governments can also buy back their high coupon (high-cost debt) bearing securities to reduce their interest outflows in the times when interest rates show a falling trend.
  • States can also retire their high-cost debt pre-maturely in order to fulfil some of the conditions put by international lenders like Asian Development Bank, World Bank etc. to grant them low-cost loans.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s accounting year

Note4Students

From UPSC perspective, the following things are important :

Prelims level: RBI's accounting year

Mains level: Read the attached story

The Reserve Bank of India (RBI) is aligning its July-June accounting year with the government’s April-March fiscal year in order to ensure more effective management of the country’s finances.

  • Accordingly, the next accounting year will be a nine-month period which starts from July 2020 and ends on March 31, 2021. Thereafter, all the financial years will start from April every year, the RBI said.
  • The Bimal Jalan Committee on Economic Capital Framework (ECF) of the RBI had proposed a more transparent presentation of the RBI’s annual accounts and change in its accounting year from July to June to April to March from the financial year 2020-21.

How did the RBI’s July-June accounting year come to be?

  • When it commenced operations on April 1, 1935, with Sir Osborne Smith as its first Governor, the RBI followed a January-December accounting year.
  • On March 11, 1940, however, the bank changed its accounting year to July-June.
  • Now, after nearly eight decades, the RBI is making another switch: the next accounting year will be a nine-month period from July 2020 to March 31, 2021, and thereafter, all financial years will start from April, as it happens with the central and state governments.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

New Umbrella Entity (NUE) for Retail Payment Systems

Note4Students

From UPSC perspective, the following things are important :

Prelims level: NUE

Mains level: Payments regulation measure by RBI

The Reserve Bank of India (RBI) has proposed to set up a new pan-India new umbrella entity (NUE) or entities focussing on retail payment systems with a minimum paid-up capital of Rs 500 crore.

New Umbrella Entity (NUE)

  • The proposed entity will set up, manage and operate new payment systems especially in the retail space.
  • It would comprise of but not limited to ATMs, white label PoS, Aadhaar-based payments and remittance services, develop payment methods, standards and technologies, monitor related issues and internationally.
  • It would take care of developmental objectives like enhancement of awareness about the payment systems.
  • The RBI retains the right to approve the appointment of directors as also to nominate a member on the board of the NUE.
  • The NUE should conform to the norms of corporate governance along with ‘fit and proper’ criteria for persons to be appointed on its board.

Functions

It will:

  • operate clearing and settlement systems
  • identify and manage relevant risks such as settlement, credit, liquidity and operational and preserve the integrity of the system
  • monitor retail payment system developments and related issues in the country and internationally to avoid shocks, frauds and contagions that may adversely affect the system and the economy in general

Terms of reference

  • The entity eligible to apply as promoter or the promoter group for the NUE should be ‘owned and controlled by residents’ with 3 years’ experience in the payments ecosystem as Payment System Operator (PSO) or Payment Service Provider (PSP) or Technology Service Provider (TSP).
  • The shareholding pattern should be diversified.
  • Any entity holding more than 25 per cent of the paid-up capital of the NUE will be deemed to be a promoter.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

RBI’s growth push

Note4Students

From UPSC perspective, the following things are important :

Prelims level: LTRO-Long Term Rero by the RBI, what is it?

Mains level: Paper 3- Novel approach adopted by the RBI to push the growth.

Context

February signalled a new dynamic-Monetary policy is no longer driven by MPC.

What changed after December MPC review

  • Pause in the rate cut by MPC: In its December policy, the Reserve Bank of India suddenly paused on cutting rates, putting the ball in the government’s court to support growth.
  • Conservative union budget: With last week’s Union Budget belying expectations of short-term growth boosters, the ball was back in the RBI’s court.
    • The Budget opted for fiscal conservativism over activism, consolidating the fiscal deficit to 3.5 per cent of GDP in 2020-21 from 3.8 per cent in 2019-20– bypassing any ambitious expenditure boost or significant tax cuts.
  • Rise in the inflation in Dec-Feb interval: Meanwhile, the policy arithmetic turned more complicated for the MPC.
    • At the time of the December policy meeting, CPI inflation was trending close to 5 per cent (the October reading was 4.6 per cent).
    • Since then a combination of supply-side shocks, which led for example to unseasonally high vegetable and protein prices, buoyed inflation to over 7 per cent, nearly 140 basis points above the RBI’s upper bound comfort zone of 6 per cent.
    • As a primarily inflation-targeting central bank, this effectively stopped the MPC from easing further

Key takeaways from February MPC meeting

  • The February policy meeting removed two key uncertainties in the current policy scenario.
  • First, the RBI is still very concerned about growth and the burgeoning negative gap between the current growth trajectory and potential growth.
  • Second, monetary policy is no longer strictly limited to the MPC’s decision-making.
    • Because of the risk of supply-side shocks hitting inflation, it is understandable that the RBI has summarised its outlook on inflation as “highly uncertain”.
    • Hence, of the policy measures that the RBI has at its disposal, the MPC’s “conventional” arrow of rate cuts was left unused.
    • Instead, the RBI has opted for macroprudential intervention, unveiling two other “unconventional” policy arrows.

RBI opting for macroprudential intervention in two ways

  • Policy transmission via LTRO-the first arrow: The primary macro challenge has been transmission via the credit channel — banks are not lowering their deposit rates.
    • Why? This is due to competition from the small savings rate and to protect saver, and in turn are keeping lending rates high.
    • How it impacts economy: Sectors considered higher risk (real estate, MSMEs) find themselves credit-starved.
    • In a move that seems inspired by the European Central Bank’s quantitative easing in 2011, the RBI’s announcement on long term repo operations (LTROs) has been aimed at promising banks longer-duration liquidity at the repo rate, which is cheaper relative to their current deposit rates.
    • The aim is to nudge them to kick-start the credit cycle.
    • The exemption of cash reserve ratio for incremental loans to MSMEs and the retail sector is also aimed at lowering costs for banks, which ideally should be passed onto these sectors.
  • Managing the stress in financial system-the second arrow: It is aimed at managing the looming stress in the financial system from bad loans, especially as deleveraging becomes more difficult during an economic slowdown.
    • Extension to restructuring durations: The extension of the restructuring scheme on MSME loans and projects in the commercial real estate sector is aimed at releasing capital for banks in the short term.
    • Though banks will ultimately need to recognise loans that are non-performing.
    • Easing guidelines on the classification of loans: Similarly, easing guidelines on the classification of loans for projects in the commercial real estate sector that have been delayed is essentially designed to provide some breathing space to banks.

What does this mean for the macro outlook?

  • Recovery in demand is a must: The RBI’s new macroprudential measures, its “unconventional” policy arrows, while well-meaning, are ultimately supply-side measures.
    • For the RBI to attain its goals, be it on asset quality or transmission, there eventually needs to be a recovery in demand conditions.
    • ECB’s LTRO experience: To be fair, even the ECB’s LTRO programme has had mixed success — a central bank can flood the market with liquidity, but the ultimate onus on releasing it to the real economy rests with banks.
    • So far, excess liquidity has not benefitted segments considered high risk (real estate developers, MSMEs).

Conclusion

The ECB introduced the LTRO programme when growth was weak and the euro area was struggling with a severe sovereign debt crisis. With the RBI embarking on something similar, albeit on a smaller scale, the niggling concern is if there is more financial instability lurking around the corner but not yet evident in the current data.

 

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

RBI Notifications

Operation Twist

Note4Students

From UPSC perspective, the following things are important :

Prelims level: Op Twist, Yeild Curve

Mains level: Outcomes of the Op Twist

Reserve Bank of India Governor has informed that the market’s reaction to Operation Twist was on expected lines.

Operation Twist

  • The simultaneous buy-sell of government bonds, known as Operation Twist, was conducted to bring down long-term interest rate while allowing short term rates to inch up.
  • The move was aimed at addressing liquidity, which is assymetric — abundant at the shorter end but not on the longer end. The move will help in monetary transmission.
  • The central bank has so far carried out three rounds of simultaneous bond buy-and-sell via open market operations.

For more reading, navigate to the page:

Operation Twist

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

Subscribe
Notify of
18 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments

JOIN THE COMMUNITY

Join us across Social Media platforms.

💥Mentorship New Batch Launch
💥Mentorship New Batch Launch