RBI Notifications

RBI: India’s central banking institution, which controls the monetary policy of the Indian rupee has been much in news this year. Macroeconomic policies for growth require coordination between the finance ministry and RBI. Let’s see where the synergies met and where they diverged!

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

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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:
1
Please leave a feedback on thisx

 

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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.

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.

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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.

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.

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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).

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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.

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

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.

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).

 

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.

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).

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.

 

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.

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/

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

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.

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.

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.

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.

 

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.

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.

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.

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.

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.

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

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.

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.

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.

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

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).

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.

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.

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.

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.

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.

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

 

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

RBI Notifications

Operation Twist

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Op Twist, Yeild Curve

Mains level : Open Market Operations by RBI

RBI is set to conduct ‘Operation Twist’ i.e. it will buy and sale government securities worth ₹10,000 crore each under its open market operations — a move aimed at managing the yields.

Why such a move?

Experts had suggested unconventional steps like this operation by the central bank as policy rate cuts are unable to bring down the bank lending rates proportionately.

What are Open Market Operations?

  • Open market operations are the sale and purchase of government securities and treasury bills by RBI or the central bank of the country.
  • The objective of OMO is to regulate the money supply in the economy.
  • When the RBI wants to increase the money supply in the economy, it purchases the government securities from the market and it sells government securities to suck out liquidity from the system.
  • OMO is one of the tools that RBI uses to smoothen the liquidity conditions through the year and minimise its impact on the interest rate and inflation rate levels.

Operation Twist

  • Operation Twist is a move taken by U.S. Federal Reserve in 2011-12 to make long-term borrowing cheaper.
  • It first appeared in 1961 as a way to strengthen the U.S. dollar and stimulate cash flow into the economy.
  • It is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds.
  • The operation describes a form of monetary policy where the bank buys and sells short-term and long-term bonds depending on their objective.

Its genesis

  • The name “Operation Twist” was given by the mainstream media due to the visual effect that the monetary policy action was expected to have on the shape of the yield curve.
  • If we visualize a linear upward sloping yield curve, this monetary action effectively “twists” the ends of the yield curve, hence, the name Operation Twist.
  • To put another way, the yield curve twists when short-term yields go up and long-term interest rates drop at the same time.

Back2Basics

Yield Curve

  • A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates.
  • The slope of the yield curve gives an idea of future interest rate changes and economic activity.https://www.thehindu.com/business/markets/rbi-to-conduct-operation-twist-to-manage-yields-on-dec-23/article30351441.ece

RBI Notifications

[oped of the day] Small savings rates need to be managed for better rate cut transmission

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Monetary Policy Transmission

Context

The slow growth of the economy requires interest rates to be eased so that money is available relatively easily and pumps up the pace of growth.

RBI’s monetary policy – Banks’ response

  • RBI has reduced interest rates, the overnight repo rate by 1.35% since February this year. 
  • However, the banks are not passing on the lower interest rate signals to lending rates.
  • In the latest policy review, RBI observed that over the period from February to September 2019, against the reduction of 110 basis points of signal repo rate, weighted average deposit rate eased by 4 bps only.
  • Weighted average lending rate on fresh rupee loans eased by 29 bps only and weighted average lending rate on outstanding rupee loans actually went up by 7 bps.

Why banks don’t pass on interest rates

  • In the past
    • A gauge called system liquidity measures how much on a daily basis banks are surplus or deficient in liquidity. 
    • It showed that banks are in deficit.
    • That was rectified through an RBI action called open market operations. RBI purchased a significant amount of government securities from banks and imparted liquidity. 
  • Slow rate of credit offtake – The pace of credit off-take from the banking system is growing at a pace slower than earlier. 
    • Credit-deposit ratio measures how much of incremental deposits in the banking system is leading to incremental loans.
    • The pace of credit off-take has slowed than earlier due to less of investments being done in the economy. 
    • The CD ratio is lower now. A lower CD ratio is the reason for banks to lower interest rates. 
  • Cost of funds – As per RBI diktat, from 1 October, floating rate loans from banks are based on an external benchmark not in the control of the bank. 
    • Fixed rate loans form the bulk of loans disbursed by banks and are benchmarked to the bank’s cost of funds. 
    • This is measured through MCLR. When MCLR comes down, banks would reduce interest rates on fixed rate loans.
  • Small savings – 
    • Banks face challenge from small savings schemes for mobilization of deposits, particularly in rural areas. 
    • Interest rates on small savings schemes are on the higher side given the context of benign inflation and the RBI having reduced the signal repo rate by 1.35%. 
    • Higher interest rates are good for depositors. Rates on small savings are market-linked, with government security yield movement of corresponding maturity.
    • Rates are reviewed every quarter. However, the rates given are much higher than what it is supposed to be as per the formula.

Small savings : Discrepancy between announced and formula based rates

  • RBI disclosed the formula-based interest rate and government-announced rates.
  • For the quarter October to December 2019, for Kisan Vikas Patra, the rate as per formula is 6.81% and the rate announced by the government is 7.60%, higher by 79 bps. 
  • For National Savings Certificate VIII Issue, the formula rate is 6.91% and the rate given is 7.90, higher by 99 bps. 
  • For Senior Citizens Saving Scheme, it is higher by 110 bps. 
  • For the spectrum of Post Office schemes, the differential over the G-Sec yield based formula is 70-110 bps. 
  • In the Union Budget, small savings has increased in importance. In 2012-13, it was 1.5% of total capital receipts. In the Budget of 2019-20, it is 16.8% of total capital receipts.

Conclusion

  • The spread of small savings stands in contrast, for the RBI measure to be transmitted to the broad system,. 
  • But, reduction of small savings rates is a sensitive issue. It will impact the masses adversely.

RBI Notifications

[oped of the day] Regulator needs to address risks to financial stability

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Monetary Policy Transmission

Op-ed of the day is the most important editorial of the day. This will cover a key issue that came in the news and for which students must pay attention. This will also take care of certain key issues students have to cover in respective GS papers.

Context

RBI’s accelerated monetary policy response since February has provided the first line of defence to India’s acute growth slowdown. Yet the pace of policy rate transmission and investment revival is very slow.

Impact of Monetary policy easing is low

  • Monetary policy easing has impacted government bonds more favourably than corporate bonds. Corporate yields did not fall because of high credit risk perception
  • Transmission through the banking channel was very slow. Leading banks lowered the 1-year MCLR by 25-40 basis points against the policy rate reduction of 110 bps. 
  • Low investment confidence was also visible in the 67% year-on-year plunge in non-convertible debentures (NCDs)
  • The investment momentum was weak because of several factors such as downgrades, unsustainable borrowings by some large companies, a continued funding crunch for NBFCs/ HFCs and low capital adequacy of public sector banks
  • Global headwinds and domestic policy flip flops further weakened the investment sentiment.
  • There is scope for further reduction in the repo rate by 35-40 bps. H

Despite falling rates, the material impact on improving investment spending remains a challenge because of the obstacles to monetary transmission. 

Reasons

  • The weight of structural factors has increased in the slowdown. Cyclical stimulus measures may not be enough to restore investment confidence.
  • Monetary policy is too blunt a tool to take care of sector-specific issues, as it simultaneously affects all sectors of the economy. 

Way ahead

  • India needs targeted interventions and sector-specific corrective measures for its ailing sectors such as infrastructure, real estate, MSMEs, export industries, and financial intermediaries such as PSBs, NBFCs/HFCs and mutual funds.
  • Fiscal stimulus worth ₹1.45 trillion through corporate tax reduction is a step in the right direction.
  • The focus of the monetary policy should shift to financial stability issues such as restoring confidence in financial intermediaries and getting credit flowing again at a reasonable price. 
  • Other corrective measures should be aimed at removing structural constraints for various productive sectors.

RBI policy

  • RBI’s policy emphasis should be on strengthening the NBFC sector – which is a dominant lender to retail, rural, housing and MSMEs, which contributes more than 20% of the total credit.
  • Two policy priorities for RBI
    • Set up a “lender of last resort” facility for NBFCs. This should undertake repo of securities, backed by NBFCs’ loan portfolio. It can be restricted to NBFCs that are more bank-like in nature, adequately capitalised and have top ratings
    • Facilitate long-term funding for NBFCs
      • At present, PSBs cannot lend to NBFCs because of capital shortage. 
      • RBI may advise the government to extend special dispensations/bank guarantees to PSBs for taking additional exposure to well-governed NBFCs. 
    • Long-term tax saving bonds may be reintroduced for infrastructure financiers. 
    • Listed NBFCs, may be kept out of the group exposure limit to improve their access to bank funds. 
    • Innovative instruments, such as covered bonds, may be promoted to make available enhanced funding from insurance/pension funds to NBFCs. 
    • RBI may also allow systemically important, well-governed, top-rated NBFCs to raise public deposits

Conclusion

Unless the regulator addresses growing risks to financial stability, monetary policy will not be effective beyond a certain limit.

RBI Notifications

RBI report on Loan Waivers impact

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not Much

Mains level : Impact of loan waivers on economy

  • Recently the RBI shared the report of an Internal Working Group (IWG), which was set up in February to look at, among other things, the impact of farm loan waivers on state finances.
  • Since 2014-15, many state governments have announced farm loan waivers.

Highlights of the report

  • The report has shown how farm loan waivers dented state finances and urged governments — both central and state — to avoid resorting to farm loan waivers.
  • This was done for a variety of reasons including relieving distressed farmers struggling with lower incomes in the wake of repeated droughts and demonetization.
  • Also crucial in this regard was the timing of elections and several observers of the economy including the RBI warned against the use of farm loan waivers.

Impact of Loan Waivers

Impact on state finances

  • Chart 1 from the RBI report details the impact on state finances in successive years.
  • Typically, once announced, farm loans waivers are staggered over three to five years.
  • Between 2014-15 and 2018-19, the total farm loan waiver announced by different state governments was Rs 2.36 trillion. Of this, Rs 1.5 trillion has already been waived.
  • For perspective, the last big farm loan waiver was announced by the UPA government in 2008-09 and it was Rs 0.72 trillion. Of this, actual waivers were only Rs 0.53 trillion — staggered between 2008-09 and 2011-12.
  • In other words, in the past five years, just a handful of states have already waived three-times the amount waived by the central government in 2008-09.
  • The actual waivers peaked in 2017-18 — in the wake of demonetization and its adverse impact on farm incomes — and amounted to almost 12 per cent of the states’ fiscal deficit.

Impact on economic growth

  • In essence, a farm loan waiver by the government implies that the government settles the private debt that a farmer owes to a bank.
  • But doing so eats into the government’s resources, which, in turn, leads to one of following two things: either the concerned government’s fiscal deficit goes up or it has to cut down its expenditure.
  • A higher fiscal deficit, even if it is at the state level, implies that the amount of money available for lending to private businesses — both big and small — will be lower.
  • It also means the cost at which this money would be lent (or the interest rate) would be higher. If fresh credit is costly, there will be fewer new companies, and less job creation.
  • If the state government doesn’t want to borrow the money from the market and wants to stick to its fiscal deficit target, it will be forced to accommodate by cutting expenditure.
  • More often than not, states choose to cut capital expenditure — that is the kind of expenditure which would have led to the creation of productive assets such as more roads, buildings, schools etc — instead of the revenue expenditure.
  • But cutting capital expenditure also undermines the ability to produce and grow in the future.

Overall impact

  • As such, farm loan waivers are not considered prudent because they hurt overall economic growth apart from ruining the credit culture in the economy since they incentivise defaulters and penalise those who pay back their loans.

How much do state finances matter for India’s macroeconomic stability?

  • Far too often, analyses of the Indian economy focuses on the Union government’s finances alone.
  • But the ground realities are fast changing. The study of state finances reveals that all the states, collectively, now spend 30 per cent more than the central government.
  • Moreover, since 2014, state governments have increasingly borrowed money from the market.
  • In 2016-17, for instance, total net borrowings by all the states were almost equal (roughly 86 per cent) of the amount that the Centre borrowed.
  • In other words, state-level finances are just as important as the central government finances for India’s macroeconomic stability and future economic growth.

Recommendations

  • The IWG recommends that GoI and state governments should undertake a holistic review of the agricultural policies and their implementation.
  • Both should evaluate the effectiveness of current subsidy policies with regard to agri inputs and credit in a manner which will improve the overall viability of agriculture in a sustainable manner.
  • It stated that loan waivers should be avoided.

RBI Notifications

[op-ed snap] Rates and risks

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Monetary policy basics

Mains level : Monetary Policy transmission issues; Interest Rate and external benchmarks

CONTEXT

The Reserve Bank of India (RBI) has mandated banks to link all new floating rate loans extended to both retail consumers as well as micro and small enterprises to an external benchmark. 

Details

  • The external benchmark could be either the repo rate or the yield on the three- or six-month Treasury bill or any other benchmark interest rate published by the Financial Benchmarks India Private Limited (FBIL). 
  • This move comes after the MCLR regime has failed to improve the transmission of monetary policy.
  • Even though the policy rate was slashed by 75 basis points between February and June 2019, lending rates declined by only 29 basis points during the same period. 

Benefits

It might lead to faster transmission of monetary policy.

Challenges

  • Mandating external benchmarking of lending rates could lead to interest rate risks because it will cut the link between bank deposit and lending rates.
  • Bank interest margins will be stressed when interest rates are falling, as lending rates will fall faster than deposit rates. 
  • Banks may increase the spread allowed to charge over the benchmark rate to cut the risks. 
  • It may also lead to banks wanting to link their deposit rates to an external benchmark. This may hurt the depositors as they may prefer the option of having fixed rates. 
  • There is also the issue of small savings instruments. These rates are more static as compared to bank deposit rates and banks will face greater competition when interest rates are going down. It could lead to a flight of deposits. 
  • The issue of which benchmark to adopt. There may be a preference for the repo rate as yields on T-bills tend are more volatile in nature. But any sudden shock to the system could push up short-term yields sharply and have to be transmitted to borrowers.

Way ahead

  • Instead of mandating external benchmarking, a preferable option would have been to allow banks to gradually move towards this framework.
  • The State Bank of India has already linked its savings deposit and short-term loans to the repo rate. Such voluntary moves could have, over time, forced others to follow suit.

 


Back2Basics

Economics | Monetary Policy Explained with Examples

RBI Notifications

External Benchmark-based Lending

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Various terms mentioned in the news

Mains level : Not Much

External Benchmark

  • The RBI has made it mandatory for all banks to link floating rate loans — to retail customers and loans to micro, small and medium enterprises (MSME) — to an external benchmark.
  • Some banks have already started to link home and auto loan rates to the repo rate, which is an external benchmark.
  • Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate.
  • The interest rate under external benchmark shall be reset at least once in three months.

Why such move?

  • At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate (MCLR).
  • It has been observed that due to various reasons, the transmission of policy rate changes to the lending rate of banks under the current MCLR framework has not been satisfactory.
  • The RBI, therefore, has issued a circular making it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019.
  • The move is aimed at faster transmission of monetary policy rates.

Repo wasn’t useful

  • Even before RBI had made it mandatory, several banks had launched repo-linked lending rate products.
  • This was done in an effort to ensure faster transmission of policy rate cuts to borrowers.
  • The repo (or repurchase) rate is the rate at which the Reserve Bank of India (RBI) lends money to other banks.
  • Hence, cuts in the repo rate are meant to lead to cuts in home loan and other lending rates as banks get to borrow money cheaply from the RBI.
  • By pegging the rate to an external benchmark RBI is hoping for a faster transmission of rate cuts than has happened so far under the MCLR system.

About MCLR

  • MCLR (Marginal Cost of funds based Lending Rate) replaced the earlier base rate system to determine the lending rates for commercial banks.
  • RBI implemented MCLR on 1 April 2016 to determine rates of interests for loans.
  • It is the minimum interest rate that a bank can lend at.
  • MCLR is a tenor-linked internal benchmark, which means the rate is determined internally by the bank depending on the period left for the repayment of a loan.
  • MCLR is closely linked to the actual deposit rates and is calculated based on four components: the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.

Back2Basics

Base Rate

  • Base rate is the minimum rate set by the RBI below which banks are not allowed to lend to its customers.
  • It is decided in order to enhance transparency in the credit market and ensure that banks pass on the lower cost of fund to their customers.
  • Loan pricing will be done by adding base rate and a suitable spread depending on the credit risk premium.

Fixed Interest Rate

  • The fixed interest rate on loan means repayment of loans in fixed equal installments over the entire period of the loan.
  • In this case, the interest rate doesn’t change with market fluctuations.

Floating Interest Rate

  • Floating interest rate by name implies that the rate of interest varies with market conditions.
  • The drawback with floating interest rates is the uneven nature of monthly installments.

RBI Notifications

[op-ed snap] Govt. needs to be prudent in using RBI’s transfer

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : RBI transferring surplus to govenrment

CONTEXT

The debate on the sharing of reserves between the RBI and the government has settled with the Bimal Jalan committee’s report. It clarified the volume of reserves required for risk provisioning to counter a financial stability crisis if it were to arise. RBI Board accepted these recommendations and decided to transfer ₹1,76,051 crore to the government. 

RBI – government relationship

Though RBI belongs entirely to the government, the integrity of its balance sheet is important to ensure financial stability and to combat market risks.

What the committee says 

  1. It concluded that provisioning has to be more stringent than in developed countries to ensure the perception of safety as India has low sovereign rating and the Indian rupee does not have reserve currency status.
  2. It suggested a revised economic capital framework that distinguishes the economic capital of RBI between ‘revaluation reserves’ and ‘realised equity’. 
  3. Revaluation reserves are a risk buffer against market risks and not available for transfer. 
  4. It used the Expected Shortfall (ES) method to measure the market risk and adopted a stringent confidence level of 99.5% against the practice of 99% by other central banks.
  5. As per the revised framework, economic capital can be in the range of 24.5% to 20% of the balance sheet. The committee recommended the range for equity to be between 6.5 to 5.5% of the balance sheet.

RBI capital transfer – benefits government

  1. RBI decided to transfer the entire surplus of ₹1,23,414 crore earned during 2018-19. It had already transferred ₹28,000 crore as interim dividend in February 2019, the remaining amount will be transferred in the current fiscal. 
  2. The additional fund transfer from RBI provides relief to the government. 
  3. Analysis of the budget shows that the tax revenue projections are too optimistic. The actual net tax revenue collection of the centre in 2018-2019 was ₹15.9 lakh crore and to achieve the budgeted target of ₹19.78 lakh crore in 2019-2020, the net tax revenue will have to increase by almost 25%. 
  4. The expected shortfall in tax revenue for the Central government is likely to be about ₹70,000 crore.
  5. With the economy slowing down and GST not yet buoyant, the shortfall may even be higher. 
  6. The infusion of additional funds will help the government to overcome this shortfall and achieve the fiscal deficit target without affecting allocations to social sector and poverty alleviation.

Challenge to states

  1. States will have to suffer the consequence of lower-than-budgeted revenue realisations. 
  2. They presented their budgets taking into account the tax devolution based on the Central budget forecast and the shortfall in collections that will adversely impact their expenditure allocations to various sectors.

Way ahead

  1. If the tax revenue growth picks up, then the government can use the additional money to clear the dues of the Food Corporation of India and fertiliser companies.
  2. The additional funds can also be used to spend on capital expenditure.

Conclusion

The decision of the RBI Board must be welcomed and should help the government in combating the economic slowdown and to conform to the fiscal targets. Government should be prudent in using these funds.

RBI Notifications

RBI Surplus

Note4Students

From UPSC perspective, the following things are important :

Prelims level : RBI profits

Mains level : Issue over transfer of surplus funds of RBI

  • The RBI Board approved a surplus transfer of Rs 1,76,051 crore to the central government.

How does a central bank like the RBI make profits?

  • The RBI is a “full service” central bank— not only is it mandated to keep inflation or prices in check, it is also supposed to manage the borrowings of the GOI and of state governments; supervise or regulate banks and NBFCs; and manage the currency and payment systems.
  • While carrying out these functions or operations, it makes profits.
  • Typically, its income comes from the returns it earns on its foreign currency assets, which could be in the form of bonds and treasury bills of other central banks or top-rated securities, and deposits with other central banks.
  • It also earns interest on its holdings of local rupee-denominated government bonds or securities, and while lending to banks for very short tenures, such as overnight.
  • It claims a management commission on handling the borrowings of state governments and the central government.

Expenditure

  • Its expenditure is mainly on the printing of currency notes and on staff.
  • Besides the commission it gives to banks for undertaking transactions on behalf of the government across the country, and to primary dealers, including banks, for underwriting some of these borrowings.

Arrangement for surplus transfer

  • The RBI isn’t a commercial organisation like the banks or other companies that are owned or controlled by the government – it does not, as such, pay a “dividend” to the owner out of the profits it generates.
  • Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalized it in January 1949, making the sovereign its “owner”.
  • What the central bank does, therefore, is transfer the “surplus” – that is, the excess of income over expenditure – to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the RBI Act, 1934.

Global practices

  • Like in India, central banks in both the UK and US decide after consultations with the government.
  • But in Japan, it is the government that decides.
  • By and large, with a few exceptions, the quantum of surplus transfer averages around 0.5% of the GDP.

Does the RBI pay tax on these earnings or profits?

  • Its statute provides exemption from paying income-tax or any other tax, including wealth tax.
  • Section 48 (Exemption of Bank from income-tax and super-tax) of the RBI Act, 1934 provides that the Bank shall not be liable to pay income-tax or super-tax on any of its income, profits or gains.

Is there an explicit policy on the distribution of surplus?

  • But a Technical Committee of the RBI Board headed by Y H Malegam, which reviewed the adequacy of reserves and a surplus distribution policy, recommended, in 2013, a higher transfer to the government.
  • Earlier, the RBI transferred part of the surplus to the Contingency Fund, to meet unexpected and unforeseen contingencies.
  • It was also transferred to the Asset Development Fund, to meet internal capital expenditure and investments in its subsidiaries to build contingency reserves of 12% of its balance sheet.
  • But after the Malegam committee made its recommendation, in 2013-14, the RBI’s transfer of surplus to the government as a percentage of gross income (less expenditure) shot up to 99.99% from 53.40% in 2012-13.

Issues

  • The government has long held the view that going by global benchmarks, the RBI’s reserves are far in excess of prudential requirements.
  • Former Chief Economic Advisor Arvind Subramanian had suggested that these funds be utilized to provide capital to government-owned banks.
  • The central bank, on its part, has traditionally preferred to be more cautious and build its reserves – keeping in mind potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets.
  • From the central bank’s perspective, bigger reserves on its balance sheet is crucial to maintaining its autonomy.

RBI Notifications

RBI accepts Bimal Jalan panel recommendations for surplus transfer

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Recommendations of the panel

Mains level : Issue over transfer of surplus funds of RBI


  • The RBI Board has decided to accept the Jalan Committee report and decided to transfer Rs 1.76 lakh crore to the government.

Bimal Jalan Committee report on Economic Capital Framework (ECF)

  • The Bimal Jalan Committee report on ECF looked into the manner in which the central bank’s surplus can be shared with the government.
  • Its report was based on the consideration of the role of central banks’ financial resilience, cross-country practices, statutory provisions and the impact of the RBI’s public policy mandate and operating environment on its balance sheet and the risks involved.
  • On the issue of the RBI’s economic capital, the committee reviewed the status, need and justification of the various reserves, risk provisions and risk buffers maintained by the RBI and recommended their continuance.

Also read-

Explained: The reserves in Reserve Bank

RBI Notifications

RBI issues final norms for regulatory sandbox

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Regulatory Sandbox

Mains level : Need for regulatory sandbox

  • The Reserve Bank of India (RBI) has issued the final framework for regulatory sandbox in order to enable innovations in the financial technology.

Regulatory Sandbox

  • A regulatory sandbox usually refers to live testing of new products or services in a controlled/test regulatory environment for which regulators may permit certain regulatory relaxations for the limited purpose of the testing.
  • The objective of the sandbox is to foster responsible innovation in financial services, promote efficiency and bring benefit to consumers.
  • It provides a secure environment for fintech firms to experiment with products under supervision of a regulator.
  • It is an infrastructure that helps fintech players live test their products or solutions, before getting the necessary regulatory approvals for a mass launch, saving start-ups time and cost.
  • The concept of a regulatory sandbox or innovation hub for fintech firms was mooted by a committee headed by then RBI executive director Sudarshan Sen.
  • The panel submitted its report in Nov 2017 has called for a regulatory sandbox to help firms experiment with fintech solutions, where the consequences of failure can be contained and reasons for failure analysed.
  • If the product appears to have the potential to be successful, it might be authorised and brought to the broader market more quickly.

What are new RBI norms?

  • RBI will launch the sandbox for entities that meet the criteria of minimum net worth of ₹25 lakh as per their latest audited balance sheet.
  • The entity should either be a company incorporated and registered in the country or banks licensed to operate in India.
  • While money transfer services, digital know-your customer, financial inclusion and cybersecurity products are included, crypto currency, credit registry and credit information have been left out.
  • Meeting norms on customer privacy, data protection, security and access to payment data, the security of transactions, KYC, anti-money laundering will be mandatory.

RBI Notifications

Regulatory Sandbox

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Regulatory Sandbox

Mains level : Functions of a regulatory sandbox

  • The Insurance Regulatory and Development Authority of India (IRDAI) will soon allow the use of regulatory sandbox (RS) to promote new, innovative products and processes in the industry.

Regulatory Sandbox

  • A sandbox approach provides a secure environment for fintech firms to experiment with products under supervision of a regulator.
  • It is an infrastructure that helps fintech players live test their products or solutions, before getting the necessary regulatory approvals for a mass launch, saving start-ups time and cost.
  • The concept of a regulatory sandbox or innovation hub for fintech firms was mooted by a committee headed by then RBI executive director Sudarshan Sen.
  • The panel submitted its report in Nov 2017 has called for a regulatory sandbox to help firms experiment with fintech solutions, where the consequences of failure can be contained and reasons for failure analysed.
  • If the product appears to have the potential to be successful, it might be authorised and brought to the broader market more quickly.
  • The sandbox will enable fintech companies to conduct live or virtual testing of their new products and services.

About IRDAI sandbox

  • For the IRDAI sandbox, an applicant should have a net worth of Rs 10 lakh and a proven financial record of at least one year.
  • Companies will be allowed to test products for up to 12 months in five categories.
  • It has said applicants can test products for up to a period of one year in five categories – insurance solicitation or distribution, insurance products, underwriting, policy and claims servicing.

Why sandbox is necessary?

  • The RS allows the regulator, the innovators, the financial service providers (as potential deployers of the technology) and the customers (as final users) to conduct field tests to collect evidence on the benefits and risks of new financial innovations, while carefully monitoring and containing their risks.
  • India accounts for approximately 6 per cent of insurance premium in Asia and around 2 per cent of the global premium volume.

RBI Notifications

Bimal Jalan Committee on RBI’s reserves

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Bimal Jalan Committee on RBI’s reserves

Mains level : RBI reserves and govt. claim over it

  • The Bimal Jalan Committee on treatment of Reserve Bank of India’s reserves is likely to recommend a transfer of a specified quantum of RBI reserves to the government.

Bimal Jalan Committee and its Terms of Reference

  • The committee was to keep in mind the statutory mandate under the RBI Act that the profits of the RBI be transferred to the government after it made provisions ‘which are usually provided by the bankers’.
  • Against this background, the committee was tasked with reviewing the status, need, and justification of the various provisions, reserves and buffers currently provided for by the RBI.
  • It was also tasked to review the global best practices followed by central banks in making provisions for the risks that central bank balance sheets are subject to.
  • The committee was also tasked with suggesting an “adequate level” of risk provisioning that the RBI should maintain, and determining whether the RBI’s current reserves were surplus of this or lower.
  • If they are surplus, then the committee also had to come up with a suitable profits distribution policy.

Quick recap: Issue over transfer of RBI surplus

  • The government and the RBI have been at loggerheads over the issue of how much of the central bank’s reserves can be transferred to the Centre.
  • The government view has been that the RBI’s reserves constitute 27% of its total assets, a much higher proportion than the global norm of 14%.
  • As a means to reach a resolution on the issue, the central bank, in December, constituted a committee under former RBI Governor Bimal Jalan.

Why govt. needs RBI money?

  • The treatment of the RBI’s reserves is a matter of great importance at a time when the central government has committed to a fiscal deficit target of 3.3% in financial year 2019-20, and a further tightening to 3% the next year.
  • With tax revenues falling short of expectations, any off-Budget receipts from the RBI will be welcomed by the Centre.

What are the key contentious issues?

  • First and foremost is the issue of transferring past reserves including unrealized gains in gold and currency revaluation accounts.
  • Most committee members favoured a reduction in the RBI’s excess reserves in a phased manner over 3 to 5 years, without any substantial additional annual transfer to the government.
  • It is not immediately clear how much excess capital has the committee identified that can be shared with the government.
  • The other big issue pertains to RBI’s profits.

What next?

  • Many economists and expert committees have in the past argued that the RBI is holding much higher capital that required to cover all its risks and contingencies.
  • Former CEA Arvind Subramanian said in Economic Survey 2016-17 that the RBI is already exceptionally highly capitalized.
  • The recommendations will be submitted to the central bank “very soon”.
  • The report is also expected to reflect the differences among the panel members over the treatment of RBI’s excess reserves.

RBI Notifications

Utkarsh 2022

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Utkarsh 2022

Mains level : RBI Regulations

Utkarsh 2022

  • The Reserve Bank of India (RBI) board has finalised a three- year roadmap to improve regulation and supervision, among other functions of the central bank.
  • This medium term strategy — named Utkarsh 2022 — is in line with the global central banks’ plan to strengthen the regulatory and supervisory mechanism.
  • Worldwide, all central banks strengthen the regulatory and supervisory mechanism; everybody is formulating a long-term plan and a medium-term plan.
  • So, the RBI has also decided it will formulate a programme to outline what is to be achieved in the next three years.
  • While around a dozen areas were identified by the committee, some board members felt that areas could be filtered and lesser number of areas can be identified for implementation in the next three years.

Why such move?

  • The idea is that the central bank plays a proactive role and takes preemptive action to avoid any crisis.
  • We are very much aware of the IL&FS debt default issue and the crisis of confidence the non-banking financial sector faced in the aftermath.

RBI Notifications

RBI introduces Complaint Management System (CMS)

Note4Students

From UPSC perspective, the following things are important :

Prelims level : RBI CMS

Mains level : Customer awareness measures by RBI

  • The RBI has launched a Complaint Management System (CMS) by providing a single window on Reserve Bank’s website for lodging complaints against any regulated entity.

Complaint Management System

  • Members of public can access the CMS portal at the central bank’s website to lodge their complaints against any of the entities regulated by RBI.
  • CMS provides auto-generated acknowledgements and enabling them to track the status of their complaints and file appeals online against the decisions of Ombudsmen, where applicable.
  • Complainants can voluntarily share feedback on their experience in obtaining redressal.
  • CMS can generate various reports for monitoring and managing complaints pertaining to each entity.
  • The CMS has self-help material (in video format) to guide the users of the portal; videos on safe banking practices; and on the regulatory initiatives of RBI.

Resolution under CMS

  • CMS facilitates the regulated entities to resolve customer complaints received through CMS by providing seamless access to their Principal Nodal Officers/Nodal Officers.
  • The complaint would be directed to the appropriate Office of the Ombudsman/ Regional Office of the RBI.
  • The benefit to the financial system will accrue from seamless access of CMS to the nodal officers of banks and financial service providers (FSPs).

Benefits

  • Customer awareness is an enabling tool for strengthening customer protection.
  • An alert and aware customer can effectively guard against the risks of mis-selling, cheating, frauds and such other threats.

RBI Notifications

Jalan panel defers report on RBI surplus funds

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Economic Capital of RBI

Mains level : Issue over transfer of surplus funds of RBI

  • A committee under former RBI governor Bimal Jalan considering guidelines for transfer of the central bank’s surplus funds to the government delayed submitting its report after lack of consensus.

Bimal Jalan Committee

  • The committee was appointed in December 2018 to review the Economic Capital Framework (ECF) for the RBI after the Finance Ministry advised the central bank to transfer surplus funds to the government.
  • The RBI has over Rs 9.6 lakh crore surplus capitals.
  • The panel has been entrusted with the task of reviewing the best practices followed by central banks worldwide in making assessment and provisions for risks.

Issue over surplus transfers

  • The government and the RBI under its previous governor Urjit Patel had been at loggerheads over the Rs 9.6 lakh crore surplus capital with the central bank.
  • The finance ministry was of the view that the buffer of 28 per cent of gross assets maintained by the central bank is well above the global norm of around 14 per cent.

What is Economic Capital?

  • Banks and financial institutions are faced with long-term future uncertainties that they intend to account for.
  • Economic capital (EC) is the amount of risk capital that a bank estimates in order to remain solvent at a given confidence level and time horizon.
  • The concept of economic capital has gained significance especially after the global financial crisis in 2008.
  • The crisis exposed many central banks in the world to multiple risks, which forced many of them US Federal Reserve, Bank of England and European Central Bank to pump in liquidity.
  • They tempted to buy securities and expand their balance sheets to boost confidence in the financial system and to ensure that critical institutions did not collapse.

Balance sheet of Central Banks

  • The balance sheet of central banks is unlike that of the institutions that it regulates or supervises.
  • They are not driven by the aim of boosting profits given their public policy or public interest role.
  • Their aim is primarily ensuring monetary and financial stability and maintaining confidence in the external value of the currency.
  • Central banks do make money or the profits earned by issuing currency which is passed on to the owner of the central bank, the government.
  • But they are typically conservative and the crisis prompted a review of the capital buffers that central banks and commercial banks needed.

Potential Risks to Central Banks

  • Traditionally, central banks have been factoring in risks such as credit risk when there could be a potential default by an entity in which there has been an investment or exposure.
  • There is also interest rate risk when interest rates either move up or slide, depending on the price of which securities or bonds held by a central bank or banks can be impacted.
  • Besides, there is operational risk when there is a failure of internal processes.
  • To measure these risks, both quantitative and qualitative methods are typically used.

The RBI proposal

  • RBI holds a huge pile of foreign exchange reserves, and as the lender of last resort it described as contingent risks arising from its public policy role in fostering monetary and financial stability.
  • In 2015, the RBI discussed this and put in place a draft Economic Capital Framework, or ECF.
  • The rationale for such a capital framework was that there were increased risks to its balance sheet.
  • RBI sought for an adequate capital buffer, critical not only to achieving its objectives, but also to ensuring the credibility of the central bank.

Concerns of RBI

  • RBI pointed out that a weak balance sheet could force the central bank to rely more on excessive seigniorage (profit made by issuing currency) income, which would run in conflict to its price stability mandate.
  • A compelling reason for RBI to build large capital buffers is to try and preempt a situation where they have to approach their governments for putting up their capital for recapitalization.
  • That is seen by them as an erosion of their operational independence.
  • The sovereign governments themselves are under fiscal strain.
  • This strengthens the case for ex-ante capitalization (based on forecasts) than ex-post capitalization i.e. better to build a capital framework way ahead of a crisis.

RBI Notifications

[op-ed snap] Eye on growth

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing Much

Mains level : Rate cut signals economy is in crisis and measures are required to boost growth.

CONTEXT

As was expected, the monetary policy committee (MPC) of the Reserve Bank of India delivered its third consecutive rate cut of 25 basis points, citing significant weakness in growth impulses.

Background

  • The repo rate now stands at 5.75 per cent. Significantly, all six members of the MPC, including Viral Acharya and Chetan Ghate who had earlier voted against monetary easing, opted not only for a loose monetary policy, but also a shift in stance from neutral to accommodative, opening the door for more rate cuts in the future.
  • The message is clear: Inflation remains contained, while the slowdown in economic activity is deeper than what was believed.

Inflation Front

  • On the inflation front, recent data points towards a broad-based pick up in prices of several food items, increasing the prospects of higher retail inflation in the coming months.
  • However, the MPC isn’t perturbed, as it expects a larger reversal in prices during autumn and winter.
  • Further, with demand weakening, core inflation has moderated, as have households expectations of three months ahead inflation.
  • The RBI now expects retail inflation at 3-3.1 per cent in the first half of FY20, rising thereafter to 3.4-3.7 per cent in the second half, well within the 4 (+/-2) per cent band.

Reasons to worry

  • In the economy though, there is reason to worry.
  • In February, the RBI had projected the economy to grow at 7.4 per cent in FY20.
  • It then lowered its forecast to 7.2 per cent in the April, and has now cut it to 7 per cent.
  • But with the underlying drivers of growth sputtering, private consumption, investment and export growth remain subdued, and with limited fiscal space, achieving even this may be difficult.

Does transmission work?

Questions –

  •  Will cuts in the repo rate translate to lower lending rates?
  • Will it boost consumption and investment demand?
  • In the policy document, the RBI noted that while the transmission of the previous two repo cuts was 21 bps to the lending rate on fresh rupee loans, the lending rate on outstanding loans increased by 4 bps as “past loans continue to be priced at higher rates”.

Optimistic notion –

  • Perhaps, with liquidity moving into surplus mode — liquidity in the system turned into an average daily surplus of Rs 66,000 crore after being in deficit in April and most of May — transmission will improve.
  • The decision to review the liquidity management framework by constituting an internal working group is a positive signal.

Conclusion

The dovish tone of the policy increases the likelihood of another rate cut in August, presumably once concerns over fiscal slippage are addressed after the budget is presented, and greater clarity emerges on the monsoon. Further rate cuts though will depend on the extent of the growth slowdown and the trajectory of inflation.

RBI Notifications

Reserve Bank proposes 24×7 NEFT money transfer

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NEFT, RTGS, IMPS

Mains level : Promoting digital transactions in India

  • The RBI has proposed to examine the possibility of extending availability of National Electronic Funds Transfer (NEFT) round-the-clock on all the seven days of the week — 24×7 basis — to facilitate beyond the banking hour fund transfer.
  • Besides, the central bank will also examine the possibility of extending the timings for Real Time Gross Settlement (RTGS) transactions.

What are NEFT and RTGS?

I. NEFT

  • NEFT is an electronic funds transfer system maintained by the Reserve Bank of India (RBI).
  • Started in November 2005, the setup was established and maintained by Institute for Development and Research in Banking Technology (IDRBT).
  • NEFT enables bank customers in India to transfer funds between any two NEFT-enabled bank accounts on a one-to-one basis. It is done via electronic messages.
  • Unlike Real-time gross settlement (RTGS), fund transfers through the NEFT system do not occur in real-time basis.

II. RTGS

  • RTGS are specialist funds transfer systems where the transfer of money or securities takes place from one bank to any other bank on a “real time” and on a “gross” basis.
  • Settlement in “real time” means a payment transaction is not subjected to any waiting period, with transactions being settled as soon as they are processed.
  • “Gross settlement” means the transaction is settled on one-to-one basis without bundling or netting with any other transaction.
  • “Settlement” means that once processed, payments are final and irrevocable.

What are the current limits?

  • Customers can transfer anywhere between Rs 1 and Rs 25 lakh via NEFT (for HDFC Bank; varies from bank to bank) through net banking in a day.
  • Through RTGS, they can transfer between Rs 2 lakh and Rs 25 lakh through net banking in a day.
  • However, as of now, these online transactions are not available on Sundays, on the second and fourth Saturdays of every month and on bank holidays.
  • On working days, NEFT is available between 8 am and 7 pm (varies from bank to bank) except on working Saturdays (8 am and 1 pm) and hence they restrict customers’ ability to carry out such transactions.
  • Online RTGS transactions are available for lesser hours. It can be done till 4 pm (varies from bank to bank).

Current options available

  • Customers can currently transfer money through Immediate Payment Service (IMPS) round the clock but the maximum amount allowed is Rs 2 lakh.
  • If RBI makes NEFT 24×7, it will not only ease the fund transfer for customers round the clock but will also take some load-off the bank branches for executing such transactions.

RBI Notifications

[op-ed snap] Regulator’s Role

Note4Students

From UPSC perspective, the following things are important :

Prelims level : RBI

Mains level : Supreme court's direction to Kotak Bank on disclosures

CONTEXT

The Supreme Court  has told the regulator that it is duty bound to disclose the list of defaulters and also make public its annual inspection reports of banks and financial institutions.

Background

  • IT is a fraught time for India’s central bank.
  • After a much publicised conflict between the government and the RBI, which finally led to the exit of Governor Urjit Patel and a knock to its institutional reputation, it has been dealt another blow by the Supreme Court.
  • The SC, while stating that the RBI had committed contempt of court, has warned the regulator that non-compliance of its order would be taken seriously as the bank had been refusing to provide information on all these under the RTI Act, citing its disclosure policy.
  • The other legal test the RBI faces is the unprecedented case of a regulated entity — the Kotak Bank — taking it to court over a regulatory ruling on lowering the shareholding of the original promoter of the bank.

Reasons for non- disclosure

1. Protecting Banking Secrecy – For long, the RBI has resisted disclosure of defaulters on the ground that it would violate banking secrecy laws while justifying holding back information and inspection reports of its supervisory teams on individual banks on fears of a weakening of trust among depositors and the impact on the financial markets and stocks of listed banks.

2. Low levels of financial Literacy – There is some truth to this argument in a country with low levels of financial literacy given that in the past, the country’s finance minister and the RBI were forced to publicly assure depositors and investors of a private bank that their money was safe after a run on the bank, fuelled by rumours.

3.Damages due to different interpretations –Similarly, realising the potential damage which could arise because of the interpretation of a provision in the Financial Resolution and Deposit Insurance Bill on protection of deposits, the government had to step in last year to assuage concerns.

Arguments in favour of disclosure

That does not, however, mean non-disclosure in perpetuity.

Based on regulatory Findings

  • One approach could be to provide this information after the RBI and the bank or an institution and its board have achieved closure and taken action based on regulatory findings, to limit any damage.
  • This could be preferably to Parliament, which could help strengthen prudential supervision.

Conclusion

  • As successive RBI governors and bankers have indicated, the pile up of bad loans in India is also because of judicial delays.
  • India’s two-year-old insolvency law has been a signature reform, but at the end of last year in over 30 per cent of the cases, the 270-day deadline had been breached.
  • It is with good reason that after the 2008 financial crisis, governments worldwide are focussed on financial stability. Any hasty step which endangers that mandate may prove costly.

RBI Notifications

RBI extends ombudsman scheme to non-deposit taking NBFCs

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NBFC, Banking Ombudsman Scheme

Mains level : Banking Ombudsman Scheme

  • The RBI has extended the coverage of Ombudsman Scheme for non-banking financial companies (NBFCs) to eligible non deposit taking non-banking financial companies (NBFC-NDs) having asset size of Rs 100 crore or above with customer interface.

What is NBFC?

  • A NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities.
  • 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.
  • A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company.

About the Ombudsman Scheme

  • The scheme was launched on February 23, 2018 for redressal of complaints against NBFCs registered with the RBI under Section 45-IA of the RBI Act, 1934 and covered all deposit accepting NBFCs to begin with.
  • It provides a cost-free and expeditious complaint redressal mechanism relating to deficiency in the services by NBFCs covered under the scheme.
  • The offices of the NBFC Ombudsmen are functioning in four metro centres — Chennai, Kolkata, Mumbai and New Delhi — and handle complaints of customers in the respective zones.
  • The scheme also provides for an appellate mechanism under which the complainant/ NBFC has the option to appeal against the decision of the Ombudsman before the Appellate Authority.

Who are excluded under the scheme?

However, non banking financial company-infrastructure finance company (NBFC-IFC), core investment company (CIC), infrastructure debt fund-non-banking financial company (IDF-NBFC) and an NBFC under liquidation, are excluded from the ambit of the scheme.

RBI Notifications

Supreme Court directs RBI to alter disclosure policy

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not Much

Mains level : RBI and autonomy issue

  • The Supreme Court gave the RBI “a last opportunity” to withdraw a November 2016 Disclosure Policy to the extent to which it stonewalls revelation of every other kind of information under the Right to Information Act, including the list of willful defaulters and annual inspection reports.

Last warning to RBI

  • The policy was found to be directly contrary to the court’s judgment of December 2015 that the Reserve Bank could not withhold information sought under the RTI Act.
  • The 2015 judgment had rejected the RBI’s argument that it could refuse information sought under the RTI on the grounds of economic interest, commercial confidence, fiduciary relationship or public interest.
  • The court had observed that there was “no fiduciary relationship between the RBI and the financial institutions”.
  • The court, in 2015, reminded the RBI that it had the statutory duty to uphold the interests of the public at large, the depositors, the economy and the banking sector.

Why did RBI refuse?

  • The RBI had refused to provide information to the petitioner, claiming “fiduciary relationship” between itself and the banks in question.
  • Such information, the regulator had then said, was exempted from being revealed under Section 8(1) (d) and (e) of the RTI Act.
  • Section 8 allows the government to withhold from public some information in order to “guard national security, sovereignty, national economic interest, and relations with foreign states”.
  • The information to the petitioners was denied by the RBI despite orders from the Central Information Commissioner (CIC) to do so.

RBI Notifications

RBI divests entire stake in NHB, NABARD

Note4Students

From UPSC perspective, the following things are important :

Prelims level : NABARD, NHB

Mains level : Disinvestment processes in India

  • The RBI has divested its remaining stake in the National Bank for Agriculture and Rural Development (NABARD) and National Housing Bank (NHB) in February and March this year.
  • The government now fully owns these two financial institutions.
  • The RBI once held 100 per cent shareholding in NHB, which was divested on March 19, 2019.

About NABARD

  • NABARD is an apex development financial institution in India, headquartered at Mumbai with regional offices all over India.
  • It is India’s specialised bank in providing credit for Agriculture and Rural Development in India.
  • The Bank has been entrusted with “matters concerning policy, planning and operations in the field of credit for agriculture and other economic activities in rural areas in India”.
  • It was established on the recommendations of B.Sivaraman Committee on 12 July 1982 to implement the NABARD Act 1981.
  • NABARD supervises State Cooperative Banks (StCBs), District Cooperative Central Banks (DCCBs), and Regional Rural Banks (RRBs) and conducts statutory inspections of these banks.

About National Housing Bank

  • NHB is an All India Financial Institution (AIFl), set up in 1988, under the National Housing Bank Act, 1987.
  • The National Housing Policy, 1988 has envisaged the setting up of NHB as the Apex level institution for housing.
  • It is an apex agency established to operate as a principal agency to promote housing finance institutions both at local and regional levels.
  • It aims to provide financial and other support incidental to such institutions and for matters connected therewith.

RBI Notifications

Ways and Means Advances

Note4Students

From UPSC perspective, the following things are important :

Prelims level : WMA

Mains level : Liquidity management measures by RBI

  • RBI may trigger fresh floatation of market loans when Government utilizes 75% of the WMA limit.
  • The interest rate on WMA will be Repo Rate and overdraft will be 2% above the Repo Rate.

Ways and means advances (WMA)

  • The Reserve Bank of India gives temporary loan facilities to the centre and state governments as a banker to government.  This temporary loan facility is called Ways and Means Advances (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.
  • 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.
  • 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.

RBI Notifications

Regulatory Sandbox for Fintech firms

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: Regulatory Sandbox

Mains level: Challenges to India as a growing fintech market


News

  • The RBI is set to issue guidelines for a ‘regulatory sandbox’ for financial technology (fintech) firms within two months.

What is Regulatory Sandbox?

  • A sandbox approach provides a secure environment for fintech firms to experiment with products under supervision of a regulator.
  • The concept of a regulatory sandbox or innovation hub for fintech firms was mooted by a committee headed by then RBI executive director Sudarshan Sen.
  • The panel, which submitted its report in November 2017, had called for a regulatory sandbox to help firms experiment with fintech solutions, where the consequences of failure can be contained and reasons for failure analysed.
  • If the product appears to have the potential to be successful, it might be authorised and brought to the broader market more quickly.
  • The sandbox will enable fintech companies to conduct live or virtual testing of their new products and services.

Why such move?

  • Fintech or financial technology companies use technology to provide financial services such as payments, peer-to-peer lending and crowdfunding, among others.
  • According to NITI Aayog, India is one of the fastest growing fintech markets globally, and industry research has projected that $1 trillion, or 60% of retail and SME credit, will be digitally disbursed by 2029.
  • The Indian fintech ecosystem is the third largest in the world, attracting nearly $6 billion in investments since 2014, the think tank said.
  • A global survey ranked India, with 1,218 fintech firms, second in terms of fintech adoption, with an adoption rate of 52 per cent.

Issue of Data Privacy

  • The risks for fintech products may arise from cross-border legal and regulatory issues where confidentiality and customer protection are major areas that needed to be addressed.
  • The proposed Personal Data Protection Bill, 2018, had categorised all financial data as “sensitive personal data”, which is not the case for many European countries.

RBI Notifications

Ind AS (Indian Accounting Standard)

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Ind AS

Mains level:  Accounting Standards of RBI


News

  • The Reserve Bank of India (RBI) has deferred the implementation of the new accounting norms, Ind AS, indefinitely, as necessary amendments to the relevant law are yet to be made.
  • The move will bring huge relief to the banks which are yet to recognise stressed assets and make necessary provisions as that would require higher capital.

Ind AS

  • Indian Accounting Standard is the Accounting standard adopted by companies in India and issued under the supervision of Accounting Standards Board (ASB) which was constituted as a body in the year 1977.
  • ASB is a committee under Institute of Chartered Accountants of India (ICAI) which consists of representatives from government department, academicians, other professional bodies viz. ICAI, representatives from ASSOCHAM, CII, FICCI, etc.
  • Ind AS governs the accounting and recording of financial transactions as well as the presentation of statements such as profit and loss account and balance sheet of a company.

Why IndAS?

  • For long, there has been a heated debate about Indian companies moving to the globally accepted International Financial Reporting Standards (IFRS) for their accounts.
  • But firms have resisted this shift, stating that this will lead too many changes in the capture and reporting of their numbers.
  • Ind AS has been evolved as a compromise formula that tries to harmonize Indian accounting rules with the IFRS.

Causes for delay

  • The implementation of IndAS for public sector banks requires an amendment to the Banking Regulation Act, 1949.
  • The schedule in Banking Regulation Act relating to financial statement disclosures needs to be changed to the IndAS format.
  • The other thing is the balance sheet format, for which some changes in the Act are required.

RBI Notifications

Voluntary Retention Route (VRR) Scheme of RBI

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: FDI, FPI, VRR

Mains level: Liquidity management policy in India


News

  • The RBI’s decision to infuse rupee liquidity through long term foreign exchange swap, a first of its kind in liquidity management policy, is likely to boost investments by foreign portfolio investors under the voluntary retention route (VRR).

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.

Benefits of VRR

  • The RBI will conduct dollar-rupee buy/sell swap action of $5 billion for a three-year tenor.
  • Such a swap route has been explored by various emerging market economies as an effective tool to manage liquidity.
  • Apart from liquidity infusion, the move will boost the country’s foreign exchange reserves and is likely to support the exchange rate.

Back2Basics

FDI and FPI

FDI and FPI in India, External Commercial Borrowings, Foreign Exchange Reserves in India

RBI Notifications

A SWIFT response could have saved banks : RBI

Image Source

Note4students

Mains Paper 2: Governance | Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

From UPSC perspective, the following things are important:

Prelims level: SWIFT

Mains level: RBI’s move preventing bank fraud


News

  • Much before the scam came that to light at the PNB in 2018, the RBI had earlier cautioned the banks about the possible misuse of the SWIFT infrastructure and directed them to implement safeguards.

Society for Worldwide Interbank Financial Telecommunication

  • The SWIFT infrastructure is the global messaging software that enables financial entities to send and receive information about financial transactions in a secure, standardised and reliable environment.
  • In order to use its messaging services, customers need to connect to the SWIFT environment.
  • Messages sent by SWIFT’s customers are authenticated using its specialised security and identification technology.
  • Messages remain in the protected SWIFT environment, subject to all its confidentiality and integrity commitments until they are safely delivered to the receiver.
  • It does not facilitate funds transfer, rather, it sends payment orders, that must be settled by correspondent accounts that institutions have with each other.
  • On receiving this message through SWIFT, banks abroad, mostly branches of domestic banks abroad provide funds to the company.

RBI fines banks for non-compliance

  • Even the PNB scam failed to wake up banks was mainly due to people and process failure not so much a technology failure.
  • Despite repeated warnings, the PNB fraud, touted to be among the biggest in the industry, happened. This prompted the banking regulator to again remind banks about the possible misuse of SWIFT.
  • The RBI came down heavily on the banks, imposing monetary penalty on 36 banks, including the SBI, ICICI Bank and the Yes Bank — to name a few.
  • These banks failed to implement the safeguard which was mainly integrating the SWIFT infrastructure with Core Banking Solution (CBS) within a time frame.
  • The Banking Regulation Act allows the RBI to impose a maximum penalty of Rs. 1 crore for a single breach.

Now, what is Core Banking Solution?

  • Core Banking Solution (CBS) is networking of branches, which enables Customers to operate their accounts, and avail banking services from any branch of the Bank on CBS network.
  • It is regardless of where he maintains his account.
  • The customer is no more the customer of a Branch. He becomes the Bank’s Customer.

Why such move?

  • One of the main reason is for not maintaining the timeline though many of them have complied with the norms now.
  • Another is, since the CBS was required to be integrated with SWIFT, the question is whether CBS was equipped for this.
  • It means compliance was required from third-party vendors and their lack of readiness also could have led to delays.
  • Third, even if the third-party software was ready, the bank may not have used it effectively.
  • And, finally, there could be some small banks who may be not have started the process.

RBI Notifications

White Label ATM

Image Source

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: WLAs and other types of ATMs

Mains level: RBI guidelines for currency handling and cyber-security framework


News

  • The RBI has relaxed norms for white label ATM (WLA) operators.
  • All guidelines, safeguards, standards and control measures applicable to banks relating to currency handling and cyber-security framework for ATMs shall also be applicable to the WLA operators, the RBI said.

Who are the White Label ATM Operators?

  • Automated Teller Machines (ATMs) set up, owned and operated by non-bank entities are called WLAs.
  • They provide the banking services to the customers of banks in India, based on the cards (debit/credit/prepaid) issued by banks.
  • Non-bank entities that set up, own and operate ATMs are called “White Label ATM Operators” (WLAO).
  • The WLAO’s role is confined to acquisition of transactions of all banks’ customers by establishing technical connectivity with the existing authorized, shared ATM and Card Payment Network Operators.

Relaxed norms by RBI

  • The RBI has been decided to allow WLAs to buy wholesale cash, above a threshold of 1 lakh pieces (and in multiples thereof) of any denomination, directly from the RBI.
  • The RBI also permitted WLA operators to source cash from any bank, including cooperatives and regional rural banks.
  • They are also being allowed to source cash from any scheduled bank, including cooperative banks and regional rural banks and to offer bill payment and Interoperable Cash Deposit services, subject to technical feasibility and certification by the National Payments Corporation of India (NPCI).
  • RBI has also allowed WLA operators to display advertisements pertaining to non-financial products or services anywhere within the WLA premises, including the ATM screen, except the main signboard.

RBI Notifications

[op-ed snap] Interim bailout: RBI surplus to govt

Note4students

Mains Paper 3: Economy | Mobilization of resources

From the UPSC perspective, the following things are important:

Prelims level: Role of RBI & various functions performed by it

Mains level: Issue of transfer of surplus reserves and various factors associated with it and need for institutionalisation of such transfer.


NEWS

CONTEXT

The central board of the Reserve Bank of India decided to transfer an interim surplus of ₹28,000 crore to the Centre.

Background

  • Together with the ₹40,000-crore final surplus share for 2017-18, which the Centre received in the first half, the total receipts from the RBI this fiscal will be a tidy ₹68,000 crore.
  • Government strapped for finances and struggling to meet the revised fiscal deficit target of 3.4% of GDP, the RBI’s largesse will be handy.
  • The total surplus received by the Centre for 2018-19 is substantially higher than the ₹50,000 crore it got from the RBI in 2017-18, and this is the second successive year the central bank is making an interim transfer: last year it transferred ₹10,000 crore.

Concerns With Such an Arrangement

  • Though there is nothing wrong in a shareholder demanding an interim dividend payout, the fact is that the Centre is advancing a receipt from the next fiscal to bail itself out in the current one.
  • Should the RBI decide not to repeat this practice, the government’s revenues will suffer because as much as ₹82,911 crore has been budgeted on this count for the next fiscal.
  • the government’s revenues will suffer because as much as ₹82,911 crore has been budgeted on this count for the next fiscal.
  • Again, the central bank is not like a corporate enterprise, nor can the government compare itself with a company shareholder.
  • The RBI’s income and surplus growth cannot be measured in commercial terms since a large part of it comes from statutory functions it has to perform as a regulator.

Recent Changes in Surplus Transfers and dividend receipts

  • The large payout this fiscal is bound to raise eyebrows, especially because of the recent history of conflict between the RBI and the Centre over the sharing of the former’s accumulated reserves as a dividend with the Centre.
  • Though the practice of an interim payout started under Mr. Patel, there are inevitable questions over whether there was pressure from the Centre now for the transfer of a higher sum than last year.
  • Centre had in the Interim Budget bumped up receipts under this head from the central bank, nationalised banks and other financial institutions to ₹74,140 crore from the original estimate of ₹54,817 crore made in the 2018-19 Budget.

Way Forward

  • There will, hopefully, be a system and a structure in place once the committee under former RBI Governor Bimal Jalan, that is now reviewing the economic capital framework for the RBI, submits its report.
  • It was constituted to de-personalise and institutionalise a system for the sharing of the RBI’s surpluses with the government.

RBI Notifications

RBI forms Nandan Nilekani-led digital payments panel

Note4students

Mains Paper 3: Economy | Mobilization of resources, Banking

From UPSC perspective, the following things are important:

Prelims level:  Panel and its terms of references

Mains level: Promotion of Digital Payments


News

Panel on Digital Payments

  • The RBI has constituted a high-level committee headed by former chairman of the UIDAI Nandan Nilekani to set up a robust digital payments ecosystem in the country.

Terms of Reference

  1. Aim: To undertake cross country analyses with a view to identify best practices that can be adopted in our country to accelerate digitization of the economy and financial inclusion through greater use of digital payments.
  2. The committee has been asked to review the existing status of digitization of payments, identify gaps in the ecosystem and suggest ways to plug them.
  3. The panel has to suggest a medium-term strategy for deepening digital payments, and measures to strengthen safety and security.
  4. It shall submit its report within a period of 90 days from the date of its first meeting.
  5. The panel has also been tasked with the responsibility of increasing customer confidence and trust while they access financial services through digital modes.

Why such move?

  1. The promotion of digital payments has been one of the primary agendas of the government in the past four years.
  2. Payments through all electronic forms such as debit and credit cards, mobile wallets, real-time gross settlement (RTGS), national electronic funds transfer (NEFT) and UPI has seen a huge rise.
  3. The newest mode of digital payments, UPI, which was launched in 2016, has witnessed an over 300% rise in transaction volumes in the last year and the growth is seen continuing in the near term.
  4. A/c to National Payments Corporation of India (NPCI) , a record 620.17 million UPI transactions worth just over ₹1 trillion were conducted in December 2018.

RBI Notifications

[op-ed snap] Signs of a turnaround: on RBI’s Financial Stability Report

Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: RBI financial stability report, Prompt corrective action.

Mains level: NPA problem and solution


Context

  1. According to the recently released Financial Stability report, The fog of bad loans shrouding the banking sector appears to be lifting after a long period of sustained stress.

Signs of turnaround

  1. The Reserve Bank of India’s Financial Stability Report reveals the first half-yearly decline in the ratio of gross non-performing assets (GNPA) to advances since September 2015.
  2. The ratio across all scheduled commercial banks has eased to 10.8% as of end-September 2018, from 11.5% in March, with both public sector and private sector lenders posting drops in the key indicator of bad loans.
  3. A stress test for credit risk at banks that models varying levels of macro-economic performance shows that for the baseline assumption, the GNPA ratio would narrow to 10.3% by March 2019.
  4. According to the FSR, among the broad sectors, the asset quality of industry sector improved in September 2018 as compared to March 2018 whereas that of agriculture and retail sectors deteriorated

Concerns

PSB still have higher level of bad loans

  1. State-owned banks continue to have higher levels of bad loans than their private sector peers and are projected to show slower improvements over the second half of the fiscal.
  2. The GNPA ratio for public sector banks (PSBs) is posited to only inch lower to 14.6% by March, from 14.8% in September.
  3. One reason is that PSBs have a disproportionately higher share of bad loans from among large borrowers, who accounted for almost 55% of loans advanced by all banks as of September. The GNPA ratio for this category at PSBs was 21.6%, compared with just 7% at private banks.

PSB may still fail to maintain the PCA

  1. Despite projections of a recovery, 18 SCBs, including all public sector banks under the prompt corrective action (PCA) framework, may fail to maintain the required capital adequacy ratio under a two SD (standard deviation) shock to the GNPA ratio, unless capital infusion takes place and banks improve their performance, according to RBI’s analysis.
  2. One SD shock equals approximately a two-percentage point increase in the GNPA ratio.
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