Analysis of Role of Reserve Bank of India and the Banking Sector in India

Analysis of Role of Reserve Bank of India and the banking sector in India Submitted by: Ankit Bohra Davis N Kunal Bhagat Nirmal Kumar J Shrabani Som Varun Sharma

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Table of Contents Banking Sector ........................................................................................................................................ 2 Role of Banks in the Economy................................................................................................................. 3 Capital Formation: .............................................................................................................................. 3 Support to the Capital Market: ........................................................................................................... 3 Rupee Loans: ....................................................................................................................................... 3 Foreign Currency Loans: ..................................................................................................................... 4 Subscription to Debentures and Guarantees ..................................................................................... 4 Assistance to Backward Areas: ........................................................................................................... 4 Promotion of New Entrepreneurs: ..................................................................................................... 4 Impact on Corporate Culture: ............................................................................................................. 5 Reserve Bank of India.......................................................................................................................... 6 The main functions of the Reserve Bank of India are: ........................................................................ 6 Issuer of currency................................................................................................................................ 6 Banker to the Government ................................................................................................................. 7 Managing Government Securities ...................................................................................................... 7 Banker to Other Banks ........................................................................................................................ 7 Controller of Money Supply and Credit .............................................................................................. 8 Exchange Manager and Controller ..................................................................................................... 8 Publisher of Monetary Data and Other Data ...................................................................................... 8 Developmental and Promotional role of RBI ...................................................................................... 9 Development of the Financial System ............................................................................................ 9 Development of Agriculture ........................................................................................................... 9 Provision of Industrial Finance ........................................................................................................ 9 Provisions of Training ...................................................................................................................... 9 Collection of Data............................................................................................................................ 9 Publication of the Reports .............................................................................................................. 9 Promotion of Banking Habits .......................................................................................................... 9 Promotion of Export through Refinance ....................................................................................... 10 Conclusion: ............................................................................................................................................ 10 References ............................................................................................................................................ 12

Banking Sectori The Indian banking industry plays an important role in the economic development of the country and is the most dominant segment of the financial sector. Banks help channel savings to investments and encourage economic growth by allocating savings to investments that have potential to yield higher returns. India’s banking system is a robust one and is classified into commercial banks and co-operative credit institutions. Commercial banks include Scheduled commercial banks (SCBs) and non-scheduled commercial banks. SCBs are further classified into public sector banks (PSBs), private banks, foreign banks and regional rural banks (RRBs). Co-operative credit institutions include the various co-operative banks.

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Role of Banks in the Economy iii Capital Formation: The significance of DFIs lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the productive capacity of the economy to the making of capital goods which increases future productive capacity. The process of Capital Formation involves three distinct but interdependent activities, viz., saving financial intermediation and investment. However, poor country/economy may be, there will be a need for institutions which allow such savings, as are currently forthcoming, to be invested conveniently and safely and which ensure that they are channelled into the most useful purposes. A well-developed financial structure will therefore aid in the collections and disbursements of investible funds and thereby contribute to the capital formation of the economy. Indian capital market although still considered to be underdeveloped has been recording impressive progress during the post-interdependence period.

Support to the Capital Market: The basic purpose of DFIs particularly in the context of a developing economy, is to accelerate the pace of economic development by increasing capital formation, inducing investors and entrepreneurs, sealing the leakages of material and human resources by careful allocation thereof, undertaking development activities, including promotion of industrial units to fill the gaps in the industrial structure and by ensuring that no healthy projects suffer for want of finance and/or technical services. Hence, the DFIs have to perform financial and development functions on finance functions, there is a provision of adequate term finance and in development functions there include providing of foreign currency loans, underwriting of shares and debentures of industrial concerns, direct subscription to equity and preference share capital, guaranteeing of deferred payments, conducting techno-economic surveys, market and investment research and rendering of technical and administrative guidance to the entrepreneurs.

Rupee Loans: Rupee loans constitute more than 90 per cent of the total assistance sanctioned and disbursed. This speaks eloquently on DFI’s obsession with term loans to the neglect of other forms of assistance which are equally important. Term loans unsupplemented by other forms of assistance had naturally put the borrowers, most of whom are small entrepreneurs, on to a heavy burden of debt-servicing. Since term finance is just one of the inputs but not everything for the entrepreneurs, they had to search for other sources and their abortive efforts to secure other forms of assistance led to sickness in industrial units in many cases.

Foreign Currency Loans: Foreign currency loans are meant for setting up of new industrial projects as also for expansion, diversification, modernization or renovation of existing units in cases where a portion of the loan was for financing import of equipment from abroad and/or technical know-how, in special cases.

Subscription to Debentures and Guarantees Regarding guarantees, it is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of instalments by the purchaser at regular intervals. In such a case, DFIs can act as guarantors for prompt of instalments to the supplier of such machinery or capital under a scheme called ‘Deferred Payments Guarantee’.

Assistance to Backward Areas: Operations of DFI’s in India have been primarily guided by priorities as spelt out in the FiveYear Plans. This is reflected in the lending portfolio and pattern of financial assistance of development financial institutions under different schemes of financing. Institutional finance to projects in backward areas is extended on concessional terms such as lower interest rate, longer moratorium period, extended repayment schedule and relaxed norms in respect of promoters’ contribution and debt-equity ratio. Such concessions are extended on a graded scale to units in industrially backward districts, classified into the three categories of A, B and c depending upon the degree of their backwardness. Besides, institutions have introduced schemes for extending term loans for project/area-specific infrastructure development. Moreover, in recent years, development banks in India have launched special programmes for intensive development of industrially least developed areas, commonly referred to as the Noindustry Districts (NID’s) which do not have any large-scale or medium-scale industrial project. Institutions have initiated industrial potential surveys in these areas.

Promotion of New Entrepreneurs: Development banks in India have also achieved a remarkable success in creating a new class of entrepreneurs and spreading the industrial culture to newer areas and weaker sections of the society. Special capital and seed Capital schemes have been introduced to provide equity type of assistance to new and technically skilled entrepreneurs who lack financial resources of their own even to provide promoter’s contribution in view of long-term benefits to the society from the emergence of a new class of entrepreneurs. Development banks have been actively involved in the entrepreneurship development programmes and in establishing a set of institutions which identify and train potential entrepreneurs. Again, to make available a package of services encompassing preparation of feasibility of reports, project reports, technical and management consultancy etc. at a reasonable cost, institutions have sponsored a chain of 16 Technical Consultancy organizations covering practically the entire country. Promotional and development functions are as important to institutions as the financing role. The promotional activities like carrying out industrial potential surveys, identification of potential entrepreneurs, conducting entrepreneurship development programmes and providing technical consultancy services have contributed in a significant manner to the process of

industrialization and effective utilization of industrial finance by industry. IDBI has created a special technical assistance fund to support its various promotional activities. Over the years, the scope of promotional activities has expanded to include programmes for up gradation of skill of State level development banks and other industrial promotion agencies, conducting special studies on important issues concerning industrial development, encouraging voluntary agencies in implementing their programmes for the uplift of rural areas, village an cottage industries, artisans and other weaker sections of the society.

Impact on Corporate Culture: The project appraisal and follow-up of assisted projects by institutions through various instruments, such as project monitoring and report of nominee directors on the Boards of directors of assisted units, have been mutually rewarding. Through monitoring of assisted projects, the institutions have been able to better appreciate the problems faced by industrial units. It also has been possible for the corporate managements to recognize the fact that interests of the assisted units and those of institutions do not conflict but coincide. Over the years, institutions have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are effecting improvements in their systems and procedures on the basis of their cumulative experience. The promoters of industrial projects now develop ideas into specific projects more carefully and prepare project reports more systematically. Institutions insist on more critical evaluation of technical feasibility demand factors, marketing strategies and project location and on application of modern techniques of discounted cash flow, internal rate of return, economic rate of return etc., in assessing the prospects of a project. This has produced a favorable impact on the process of decision-making in the corporate seeking financial assistance from institutions. In fact, such impact is not continued to projects assisted by them but also spreads over to projects financed by the corporate sector on its own. The association of institutions in the management of corporate bodies has considerably facilitated the process of progressive professionalism of the corporate management. Institutions have been able to convince the corporate managements to appropriately re-orient their organizational structure, personal policies and planning and control systems. In many cases, institutions have successfully inducted experts on the Boards of assisted companies. As part of their project follow-up work and through their nominee directors, institutions have also been able to bring about progressive adoption of modern management techniques, such as corporate planning and performance budgeting in the assisted units. The progressive professionalism of industrial management in India reflects one of the major qualitative changes brought about by the institutions.

Reserve Bank of Indiaivv Reserve Bank of India (RBI) is India's central bank - it formulates, implements and monitors India's monetary policy. Reserve bank of India was established in 1935 and nationalized in 1949. It is fully owned by the Government of India and its headquarters are located in Mumbai. RBI has 22 regional offices in the various state capitals of India. It has a majority stake in the State Bank of India.

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The main functions of the Reserve Bank of India are: As a central bank, the Reserve Bank has significant powers and duties to perform. For smooth and speedy progress of the Indian Financial System, it has to perform some important tasks. Among others it includes maintaining monetary and financial stability, to develop and maintain stable payment system, to promote and develop financial infrastructure and to regulate or control the financial institutions.

Issuer of currency Except for issuing one rupee notes and coins, RBI is the sole authority for the issue of currency in India. The Indian government issues one rupee notes and coins. Major currency is in the form of RBI notes, such as notes in the denominations of two, five, ten, twenty, fifty, one hundred, five hundred, and one thousand. Earlier, notes of higher denominations were

also issued. But, these notes were demonetized to discourage users from indulging in blackmarket operations. RBI has two departments - the Issue department and Banking department. The issue department is dedicated to issuing currency. All the currency issued is the monetary liability of RBI that is backed by assets of equal value held by this department. Assets consist of gold, coin, bullion, foreign securities, rupee coins, and the government’s rupee securities. The department acquires these assets whenever required by issuing currency. The conditions governing the composition of these assets determine the nature of the currency standard that prevails in India. The Banking department of RBI looks after the banking operations. It takes care of the currency in circulation and its withdrawal from circulation. Issuing new currency is known as expansion of currency and withdrawal of currency is known as contraction of currency.

Banker to the Government RBI acts as banker, both to the central government and state governments. It manages all the banking transactions of the government involving the receipt and payment of money. In addition, RBI remits exchange and performs other banking operations. RBI provides short-term credit to the central government. Such credit helps the government to meet any shortfalls in its receipts over its disbursements. RBI also provides short term credit to state governments as advances. RBI also manages all new issues of government loans, servicing the government debt outstanding, and nurturing the market for government’s securities. RBI advises the government on banking and financial subjects, international finance, financing of five-year plans, mobilizing resources, and banking legislation.

Managing Government Securities Various financial institutions such as commercial banks are required by law to invest specified minimum proportions of their total assets/liabilities in government securities. RBI administers these investments of institutions. The other responsibilities of RBI regarding these securities are to ensure  Smooth functioning of the market  Readily available to potential buyers  Easily available in large numbers  Undisturbed maturity-structure of interest rates because of excess or deficit supply  Not subject to quick and huge fluctuations  Reasonable liquidity of investments  Good reception of the new issues of government loans

Banker to Other Banks The role of RBI as a banker to other banks is as follows:

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Holds some of the cash reserves of banks Lends funds for short period Provides centralized clearing and quick remittance facilities

RBI has the authority to statutorily ensure that the scheduled commercial banks deposit a stipulated ratio of their total net liabilities. This ratio is known as cash reserve ratio [CRR]. However, banks can use these deposits to meet their temporary requirements for interbank clearing as the maintenance of CRR is calculated based on the average balance over a period.

Controller of Money Supply and Credit In a planned economy, the central bank plays an important role in controlling the paper currency system and inflationary tendency. RBI has to regulate the claims of competing banks on money supply and credit. RBI also needs to meet the credit requirements of the rest of the banking system. RBI needs to ensure promotion of maximum output, and maintain price stability and a high rate of economic growth. To perform these functions effectively, RBI uses several control instruments such as  Open Market Operations  Changes in statutory reserve requirements for banks  Lending policies towards banks  Control over interest rate structure  Statutory liquidity ration of banks

Exchange Manager and Controller RBI manages exchange control, and represents India as a member of the international Monetary Fund [IMF]. Exchange control was first imposed on India in September 1939 when World War II started and continues till date. Exchange control was imposed on both receipts and payments of foreign exchange. According to foreign exchange regulations, all foreign exchange receipts, whether on account of export earnings, investment earnings, or capital receipts, whether of private or government accounts, must be sold to RBI either directly or through authorized dealers. Most commercial banks are authorized dealers of RBI.

Publisher of Monetary Data and Other Data RBI maintains and provides all essential banking and other economic data, formulating and critically evaluating the economic policies in India. In order to perform this function, RBI collects, collates and publishes data regularly. Users can avail this data in the weekly statements, the RBI monthly bulletin, annual report on currency and finance, and other periodic publications.

Developmental and Promotional role of RBI Along with the routine traditional functions, central banks especially in the developing country like India have to perform numerous functions. These functions are country specific functions and can change according to the requirements of that country. The RBI has been performing as a promoter of the financial system since its inception. Some of the major development functions of the RBI are maintained below. Development of the Financial System: The financial system comprises the financial

institutions, financial markets and financial instruments. The sound and efficient financial system is a precondition of the rapid economic development of the nation. The RBI has encouraged establishment of main banking and non-banking institutions to cater to the credit requirements of diverse sectors of the economy. Development of Agriculture: In an agrarian economy like ours, the RBI has to provide

special attention for the credit need of agriculture and allied activities. It has successfully rendered service in this direction by increasing the flow of credit to this sector. It has earlier the Agriculture Refinance and Development Corporation (ARDC) to look after the credit, National Bank for Agriculture and Rural Development (NABARD) and Regional Rural Banks (RRBs). Provision of Industrial Finance: Rapid industrial growth is the key to faster economic

development. In this regard, the adequate and timely availability of credit to small, medium and large industry is very significant. In this regard the RBI has always been instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc. Provisions of Training: The RBI has always tried to provide essential training to the staff of

the banking industry. The RBI has set up the bankers' training colleges at several places. National Institute of Bank Management i.e NIBM, Bankers Staff College i.e BSC and College of Agriculture Banking i.e CAB are few to mention. Collection of Data: Being the apex monetary authority of the country, the RBI collects

process and disseminates statistical data on several topics. It includes interest rate, inflation, savings and investments etc. This data proves to be quite useful for researchers and policy makers. Publication of the Reports: The Reserve Bank has its separate publication division. This

division collects and publishes data on several sectors of the economy. The reports and bulletins are regularly published by the RBI. It includes RBI weekly reports, RBI Annual Report, Report on Trend and Progress of Commercial Banks India., etc. This information is made available to the public also at cheaper rates. Promotion of Banking Habits: As an apex organization, the RBI always tries to promote the

banking habits in the country. It institutionalizes savings and takes measures for an expansion

of the banking network. It has set up many institutions such as the Deposit Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-1982, NHB-1988, etc. These organizations develop and promote banking habits among the people. During economic reforms it has taken many initiatives for encouraging and promoting banking in India. Promotion of Export through Refinance: The RBI always tries to encourage the facilities

for providing finance for foreign trade especially exports from India. The Export-Import Bank of India (EXIM Bank India) and the Export Credit Guarantee Corporation of India (ECGC) are supported by refinancing their lending for export purpose Other major roles of RBI in the Indian Economy are: 

Development of banking system

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Development of financial institutions

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Development of backward areas

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Economic stability

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Economic growth

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Proper interest rate structure

Conclusion: India’s financial system has undergone development as part of the economic reform process that began in 1990. This has resulted in the expansion of both the banking sector and the stock market. However, India’s banking sector remains relatively small compared with those of most East Asian economies, and there appears to be scope for further expansion. Individual banks are also small by international standards. Furthermore, the corporate bond market is still immature and has not yet started to develop on a significant scale. India’s rapid growth since 2000 has been accompanied by a rise in the savings and investment rates. Procurement of external financial resources by businesses has risen sharply, and bank borrowing has played a significant role. This suggests that external financing can be expected to remain a significant factor in the maintenance of high economic growth, and that the continuing development of the banking sec-tor, including the improvement of financial intermediation capabilities and efficiency with which funds are distributed, will be a priority. There is also likely to be further growth in the demand for finance for infrastructure development. In addition to the expansion of bank credit, there is also a need for steps to maintain soundness, including the improvement of risk management capabilities, and the reinforcement of regulation and supervision. Banking reforms introduced since the 1990s have included the easing regulations that restricted competition, and the introduction of prudential regulations. These changes have

resulted in the entry of private sector banks and foreign banks into the market, leading to increased competition. To some extent, the reforms have also brought improvements in the efficiency and soundness of banks and led to the expansion of bank credit. The banking reform process can be seen as a positive factor that is steadily yielding benefits. However, many issues remain. Factors affecting the size of the banking sector and the expansion of credit include the fact that financial savings still account for only a small percentage of household savings. Furthermore, while there has been an upward trend in the percentage of credit provided to individuals, there has been a decline in the share going to the industrial sector. Of particular concern is the stagnation of credit to small and medium enterprises (SMEs). Improvement in these areas will require action to deal with a number of structural problems. First, the government should review the statutory liquidity ratio (SLR), which stipulates the percent-age of deposits that must be invested in government bonds. Second, improvements are needed in priority sector lending, which are designed to expand credit to agriculture and SMEs, since banks are unable to secure adequate returns. Third, India has implemented a financial inclusion policy with the aim of expanding the use of formal finance, primarily through the expansion of a network of bank branches in the rural areas. The effectiveness of this policy needs to be improved through diversification. To increase the size of individual banks, the government should consider measures that will encourage bank mergers while maintaining a competitive environment. A longer-term priority will be a review of bank ownership by the government in order to improve the competitiveness of public sector banks. Some observers see the fact that the Indian banking sector has never experienced a major financial crisis as evidence that there are no serious problems. However, the ratio of domestic credit to GDP is not high by international standards, and the scale of individual banks is relatively small. There are also characteristic systems, including priority sector lending and government ownership of banks. India’s rapid growth since 2000 has been ac-companied by increases in both savings and in-vestment rates. This process has also brought an increase in external procurement of financial resources. This suggests that external financing plays an important role in the achievement of high economic growth. Priorities in this context include the structural expansion of bank credit through the expansion of financial savings, and the improvement of the efficiency of financial intermediation and the allocation of financial resources. These goals will require further improvements in the efficiency of the banking sector, and the setting of loan and deposit interest rates at levels that reflect market realities. Other essential steps include a review of the statutory liquidity ratio (SLR) system and priority sector lending, and the promotion of financial inclusion. When designing financial inclusion systems, including priority sector lending, greater emphasis will need to be placed on economic rationality. To expand financial savings, it will also be necessary to focus on measures to reduce the number of informal sector enterprises, including the expansion of rural employment. By further developing its banking sector and building a strong financial system, India should be able to look forward to sustained high growth over many years.

References i

rbidocs.rbi.org.in/rdocs/Speeches/PDFs/FIBACS130813.pdf http://en.wikipedia.org/wiki/Banking_in_India iii www.herald.co.zw/role-of-banks-in-the-economy/ iv http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIB140520012.pdf v http://rbidocs.rbi.org.in/rdocs/Content/PDFs/FUNCWWE080910.pdf vi http://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=OrganizationStructure.htm ii