RBI Credit Policy (Rough)
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Banking Law, Credit policy, Monetary policy, Reserve Bank of India, Tools of monetary policy...
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RBI Credit Policy
INTRODUCTION The Reserve Bank of India as the Central Bank of our country was established on 1 st April, 19! under the Reserve Bank of India Act, 19"# The Bank was started ori$inally as a shareholders% bank and its paid up capital was Rs# ! crores# The Bank took over the function of currency issue fro& the 'overn&ent of India and the power of credit control fro& the then I&pe I&peri rial al Bank Bank of Indi India# a# The The Bank Bank was was nati nation onal alis ised ed in the the year year 19"( 19"(,, soon soon afte after r Independen Independence, ce, followin$ a post war trend towards nationalisation nationalisation of Central Central Banks Banks all over the world# Also a centrally ad&inistered syste& had then beco&e necessary to control a runaway inflation ra$in$ in India since 199, control inflation in the country effectively# And, And, as India had to e&bark upon a pro$ra&&e of econo&ic develop&ent and $rowth, it was necessary to have a co&plete control over the activities of bankin$ so that a Central Bank could be used effectively as an instru&ent of econo&ic chan$e in the country# This power of Credit control of RBI as taken fro& the then I&perial Bank is &ainly for&in$ RBI%s Credit Policy# Throu$h credit policy RBI controls flow of credit in do&estic &arket as one of its i&portant functions involve control over the volu&e of credit created by the co&&ercial banks in order to ensure price stability# The Reserve Bank of India is lar$ely concerned with or$anisation of a sound and healthy co&&ercial bankin$ syste&, ensurin$ effective co)ordination and control over credit throu$h appropriate appropriate &onetary and credit policies followed fro& ti&e to ti&e# *owever, *owever, in India the Reserve Bank of India is also concerned with develop&ent of rural bankin$, pro&otion of financial institutions and develop&ent of &oney and capital &arket in India# +eepin$ in view, the functions of RBI of credit control alon$ with the develop&ental aspects, the credit policy for a nation is for&ulated in both uantitative &easures and ualitative &easures to control both uantity of credit and uality of work to be for&ulated by that credit# Issue of credit policy for Banking Companies :
The bank for&ulates credit policies, nor&ally by way of an order, by layin$ down the bank rate, lendin$ restrictions, &er$er restrictions, nature of security to be obtained for credit e-tension, definin$ the scope and eli$ibility of the private sector for borrowin$, deter&inin$
the cash reserve ratio and statutory liuidity ratio and any other &atter havin$ a bearin$ on co&&ercial lendin$ in the first instance, and the econo&y of the country in the second# It has been custo&ary for RBI to announce a set of &easures of both short)ter& and structural nature in the two bi)annual state&ents on &onetary and credit policy nor&ally released in April and .ctober of each year#
CREDIT POIC! " #ONET$R! POIC! O% RBI & CONCEPTU$ $N$!'I' #eaning
/onetary policy co&prises i&ple&entation of &easures that will result either in contraction or e-pansion of &oney supply in the econo&y and thereby re$ulate inflation in prices# Banks bein$ purveyors of credit, they act as chan$e a$ents by re$ulatin$ the volu&e of liuidity for industries as a &easure to control prices of $oods and services# As the re$ulatory authority, the RBI &onitors bank credit throu$h directives alterin$ Cash Reserve and 0tatutory iuidity Ratios for Banks, a&endin$ its own lendin$ rate, known as the Bank Rate, stipulatin$ &ini&u& &ar$ins to be retained by banks in their advances and also reviewin$ co&&odities $overned by the 0elective Credit Control# The /onetary and Credit Policy is the policy state&ent, traditionally announced twice a year, throu$h which the Reserve Bank of India seeks to ensure price stability for the econo&y# The Reserve Bank of India enunciates its &onetary policy once a year, but announces a &id) course review si- &onths thereafter# These factors include ) &oney supply, interest rates and the inflation# In bankin$ and econo&ic ter&s &oney supply is referred to as / ) which indicates the level 2stock3 of le$al currency in the econo&y# Besides, the RBI also announces nor&s for the bankin$ and financial sector and the institutions which are $overned by it# These would be banks, financial institutions, non)bankin$ financial institutions, 4idhis and pri&ary dealers 2&oney &arkets3 and dealers in the forei$n e-chan$e 2fore-3 &arket# 1 *istorically, the /onetary Policy is announced twice a year ) a slack season policy 2April) 0epte&ber3 and a busy season policy 2.ctober)/arch3 in accordance with a$ricultural cycles# These cycles also coincide with the halves of the financial year# Initially, the Reserve Bank of India announced all its &onetary &easures twice a year in the /onetary and Credit Policy# The /onetary Policy has beco&e dyna&ic in nature as RBI reserves its ri$ht to alter it fro& ti&e to ti&e, dependin$ on the state of the econo&y#
1 0alil Panchal, 56hat is RBI%s /onetary Policy%, /orpheus Inc## Available at7 8 http7&#rediff#co&&oney:;;:apr:!tut#ht&nsurin$ adeuate e-pansion of credit for the purpose of &eetin$ $enuine credit reuire&ents of productive sectors of the econo&y#
?ntil the econo&ic refor&s were introduced durin$ the nineties, the prevailin$ syste& of ad&inistered interest rates was $eared towards achievin$ the twin ob=ectives of allocation of resources for capital for&ation and directin$ credit to preferred sectors, often at concessionary interest rates# The ad&inistered interest rate re$i&e clearly circu&scribed the role of interest rate as an effective instru&ent of &onetary &ana$e&ent# The efficacy of the policy hin$es on the identification of the tar$ets by the &onetary authority# Conceptually, such tar$ets are distin$uished as inter&ediate and ulti&ate# 6hereas inflation rate is an a$reeable ulti&ate tar$et of &onetary policy, variables such as different &easures of &oney supply andor interest rates could be e&ployed to serve as inter&ediate tar$ets# In India, while broad &oney, or what is referred as /), $rowth has been chosen to function as inter&ediate tar$et, the operatin$ tar$et is the level of Bank#
: Ibid#
The ob=ectives are to &aintain price stability and ensure adeuate flow of credit to the productive sectors of the econo&y# 0tability for the national currency 2after lookin$ at prevailin$ econo&ic conditions3, $rowth in e&ploy&ent and inco&e are also looked into# The &onetary policy affects the real sector throu$h lon$ and variable periods while the financial &arkets are also i&pacted throu$h short)ter& i&plications# There are four &ain @channels@ which the RBI looks at7 •
uantu& channel7 &oney supply and credit 2affects real output and price level throu$h chan$es in reserves &oney, &oney supply and credit a$$re$ates3#
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Interest rate channel#
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>-chan$e rate channel 2linked to the currency3#
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Asset price#
/onetary Policy is the process by which the &onetary authority of a country, $enerally a Central Bank controls the 0upply of &oney in the >cono&y by e-ercisin$ its control over interest rates in order to &aintain)
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'rowth with 0tability
evelop&ent of Dinancial 0tability >&ploy&ent ¬ >-ternal 0tability
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Re$ulation, 0upervision
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Pro&otin$ Priority 0ector
>ncoura$in$ 0avin$ Invest&ent
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'eneration of
Redistribution of
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inco&e wealth Role of /onetary Policy in Co&batin$ Inflation www#iosr=ournals#or$ 1: E Pa$e ¬ Re$ulation of 4BDI OB+ECTI,E' O% #ONET$R! POIC! O% INDI$ :-
The &ain ob=ective of &onetary policy in India is 5$rowth with stability%# /onetary /ana$e&ent re$ulates availability, cost and use of &oney and credit# It also brin$s institutional chan$es in the financial sector of the econo&y# Dollowin$ are the &ain ob=ectives of &onetary policy in India 7) ./
0ro1t2 3it2 'ta(ility :-
Traditionally, RBI%s &onetary policy was focused on controllin$ inflation throu$h contraction of &oney supply and credit# This resulted in poor $rowth perfor&ance# Thus, RBI have now adopted the policy of 5'rowth with 0tability%# This &eans sufficient credit will be available for $rowin$ needs of different sectors of econo&y and at the sa&e ti&e, inflation will be controlled with in a certain li&it#
4/
Regulation5 'uper*ision $nd De*elopment Of %inancial 'ta(ility :-
Dinancial stability &eans the ability of the econo&y to absorb shocks and &aintain confidence in financial syste&# Threats to financial stability can co&e fro& internal and e-ternal shocks# 0uch shocks can destabiliFe the country%s financial syste&# Thus, $reater i&portance is bein$ $iven to RBI%s role in &aintainin$ confidence in financial syste& throu$h proper re$ulation and controls, without sacrificin$ the ob=ective of $rowth# Therefore, RBI is focusin$ on re$ulation, supervision and develop&ent of financial syste&#
6/
Promoting Priority 'ector :-
Priority sector includes a$riculture, e-port and s&all scale enterprises and weaker section of population# RBI with the help of bank provides ti&ely and adeuately credit at affordable cost of weaker sections and low inco&e $roups# RBI, alon$ with 4ABAR, is focusin$ on &icrofinance throu$h the pro&otion of 0elf *elp $roups and other institutions#
7/
0eneration Of Employment :-
/onetary policy helps in e&ploy&ent $eneration by influencin$ the rate of invest&ent and allocation of invest&ent a&on$ various econo&ic activities of different labour Intensities#
8/
E9ternal 'ta(ility :-
6ith the $rowth of i&ports and e-ports India%s linka$es with $lobal econo&y are $ettin$ stron$er# >arlier, RBI controlled forei$n e-chan$e &arket by deter&inin$ ea-chan$e rate# 4ow, RBI has only indirect control over e-ternal stability throu$h the &echanis& of
5&ana$ed Dle-ibility%, where it influences e-chan$e rate by buyin$ and sellin$ forei$n currencies in open &arket#
/
Encouraging 'a*ings $nd In*estments :-
RBI by offerin$ attractive interest rates encoura$e savin$s in the econo&y# A hi$h rate of savin$ pro&otes invest&ent# Thus the &onetary &ana$e&ent by influencin$ rates of interest can influence savin$ &obiliFation in the country#
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Redistri(ution Of income $nd 3ealt2 :-
By control of inflation and deploy&ent of credit to weaker sectors of society the &onetary policy &ay redistribute inco&e and wealth favourin$ to weaker sections#
U$IT$TI,E CREDIT CONTRO #ET?OD' :-
?nder 0elective Credit Control, credit is provided to selected borrowersfor selected purpose, dependin$ upon the use to which the control try to re$ulate the uality of credit ) the direction towards the credit flows# The 0elective Controls are 7) ./ Ceiling On Credit
The Ceilin$ on level of credit restricts the lendin$ capacity of a bank to $rant advances a$ainst certain controlled securities# 4/ #argin Reuirements
A loan is sanctioned a$ainst Collateral 0ecurity# /ar$in &eans that proportion of the value of security a$ainst which loan is not $iven# /ar$in a$ainst a particular security is reduced or increased in order to encoura$e or to discoura$e the flow of credit to a particular sector# It varies fro& :;K to (;K# Dor a$ricultural co&&odities it is as hi$h as H!K# *i$her the &ar$in lesser will be the loan sanctioned# 6/ Discriminatory Interest Rate @DIRA
Throu$h IR, RBI &akes credit flow to certain priority or weaker sectors by char$in$ concessional rates of interest# RBI issues supple&entary instructions re$ardin$ $rantin$ of additional credit a$ainst sensitive co&&odities, issue of $uarantees, &akin$ advances etc# # 7/ Directi*es
The RBI issues directives to banks re$ardin$ advances# irectives are re$ardin$ the purpose for which loans &ay or &ay not be $iven# 8/ Direct $ction
It is too severe and is therefore rarely followed# It &ay involve refusal by RBI to rediscount bills or cancellation of license, if the bank has failed to co&ply with the directives of RBI# / #oral 'uasion
?nder /oral 0uasion, RBI issues periodical letters to bank to e-ercise control over credit in $eneral or advances a$ainst particular co&&odities# Periodic discussions are held with authorities of co&&ercial banks in this respect#
>MA?ATI.4 .D /.4>TARN P.ICN 7) The RBI ai&s at one ti&e was controlled e-pansion# .n one hand it was takin$ steps to e-pand bank credit# .n other hand RBI uses uantitative and ualitative ðods to control credit# These two contradictory ob=ectives li&ited the success of &onetary policy# The perfor&ance of &onetary policy can be seen fro& its achieve&ents and failures, let us discuss# AC*I>M>/>4T0 .R T*> P.0ITIM> A0P>CT0 .D /.4>TARN P.ICN 7) 1# 0hort Ter& iuidity /ana$e&ent 7) RBI has developed various ðods to &aintain stability in interest rate and e-chan$e rate like AD, ./. and /00# RBI has also &ana$ed its st erliFation operations very well# :# Dinancial 0tability 7) 6ith the help of controls, re$ulation and s upervision &echanis&, RBI has been successful in &aintainin$ financial stability# urin$ the period of $lobal crisis it has also been able to &aintain &acro econo&ic stability# # Dinancial Inclusion 7) Alon$ with 4ABAR, RBI has &ade a $reat i&pact in the $rowth of &icrofinance# RBI has supported 0elf *elp 'roup /odel and pro&oted other &icrofinance institutions# "# Adaptability7) In India &onetary policy is fle-ible, as it chan$es with ti &e# RBI has developed new ðods of credit control and shifted fro& &onetary tar$etin$ to &ultiple indicator approach# !# Increase In 'rowth7) To &aintain the $rowth of econo&y RBI has used its instru&ents@ effectively# At present India has the second hi$hest rate of 'P $rowth after China# Thus &onetary policy has pla yed an i&portant role# J# Increase In Bank eposits7) The increase in bank deposits over the years indicates trust and confidence of people in bankin$ sector# >ffective supervision of RBI over banks and financial institutions is lar$ely responsible for trust and confidence of public in bankin$ sector# H# Co&petition A&on$ Banks 7) The &onetary policy of RBI has resulted in healthy co&petition a&on$ banks in the country# The co&petition is due to dere$ulation of interest rates and other &easures taken by RBI# 4ow)a)days due to professionalis& banks provide better service to custo&ers# DAI?R>0 .R T*> I/ITATI.40 .D /.4>TARN P.ICN 1# *u$e Bud$etary eficits 7) RBI &akes every possible atte&pt to control inflation and to balance &oney supply in the &arket# *owever Central 'overn&ent@s hu$e bud$etary deficits have &ade &onetary policy ineffective# *u$e bud$etary deficits have resulted in e-cessive &onetary $rowth#
:# Covera$e .f .nly Co&&ercial Banks 7) Instru&ents of &onetary policy cover only co&&ercial banks so inflationary pressures caused by bankin$ finance can be controlled by RBI, but in India, inflation also results fro& deficit financin$ and scarcity of $oods on which RBI &ay not have any control# # Proble& .f /ana$e&ent .f Banks And Dinancial Institutions 7) The &onetary policy can succeed to control inflation and to brin$ overall develop&ent only when the &ana$e&ent of banks and Dinancial institutions are efficient and dedicated# /an y officials of banks and financial institutions are corrupt and inefficient which leads to financial sca&s in this wa y overall econo&y is affected# "# ?nor$anised /oney /arket 7) Presence of unor$anised sector of &oney &arket is one of the &ain obstacle in effective workin$ of the &onetary policy# As RBI has no power over the unor$anised sector of &oney &arket, its &onetary policy beco&es less effective# !# ess Accountability7) At present ti&e, the $oals of &onetary policy in India, are not set out in specific ter&s and there is insufficient freedo& in the use of instru&ents# In such a settin$, accountability tends to be weak as there is lack of clarity in the responsibility of $overn&ents and RBI# J# Black /oney 7) There is a $rowin$ presence of black &oney in the econo&y# Black &oney falls beyond the purview of bankin$ control of RBI# It &eans lar$e proposition of total &oney 0upply in a country re&ains outside the purview of RBI@s &onetary &ana$e&ent# H# Increase Molatility 7) The inte$ration of do&estic and forei$n e-chan$e &arkets could lead to increased volatility in the do&estic &arket as the i&pact of e-o$enous factors could be trans&itted to do&estic &arket# The widenin$ of forei$n e-chan$e &arket and develop&ent of rupee ) forei$n e-chan$e swap would reduce risks and volatility# (# ack .f Transparency 7) Accordin$ to 0# 0# Tarapore, the &onetary policy for&ulation, in its present for& in India, cannot be continued indefinitely# Dor a &ore effective policy, it would be necessary to have $reater transparency in the policy for&ulation and trans&ission process and the RBI would need to be clearly de&arcated# C.4C?0I.4 7) Thus, fro& above we can say that despite several proble&s RBI has &ade a $ood effort for effective i&ple&entation of the &onetary policy in India#
/onetary policy in India underwent si$nificant chan$es in the 199;s as the Indian>cono&y beca&e increasin$ open and financial sector refor&s were put in place# in the19(;s,&onetary policy was $eared towards controllin$ the unata&,cost and directions.f credit flow in the econo&y# the uantity variables do&inated as the trans&issionChannel of &onetary policy# Refor&s durin$ the 199;s enhanced the sensitivity of price0i$nals of price si$nals fro& the central bank, &akin$ interest rates the increasin$lyo&inant trans&ission channel of &onetary policy in India#The openness of the econo&y, as &easured by the ratio of &erchandise trade2e-portsPlus i&ports3 to 'P, rose fro& about 1(K in 199)9" to about :JK by :; ;);"#Includin$ services trade plus invisibles, e-ternal transactions as a proportion of 'PRose fro& :!K to ";K durin$ the sa&e period#Alon$with the increase in trade as aPercenta$e of 'P, capital inflows have increased even &ore sharply,forei$n currencyAssets of the reserve bank of India2RBI3 rose fro& ?0 1!#1 billion in the &arch 199"To over ?0 1"; billi on by &arch 1!,:;;!#these chan$es have affected liuidity and/onetary &ana$e&ent# &onetary policy has responded continuously to chan$es ino&estics and international &acroeco&ic conditions# In this process, the current&onetary operatin$ fra&ework has relied &ore on outri$ht open &arket operations andaily repo and reserve repo operations than on the use of direct instru&ents#overi$htRate are now $radually e&er$in$ as the principal operatin$ tar$et#The /onetary and Credit Policy is the policy state&ent, traditionall y announcedtwice a year, throu$h which the Reserve Bank of India seeks to ensure price stabilit y for the econo&y# These factors include ) &oney supply, interest rates and the inflation#
I&portance of /onetary Policy The $rowin$ i&portance of &onetary policy and the di&inishin$ role played by fiscal policin$ econo&ic stabiliFation efforts &ay reflect both political and econo&ic realities# Di$htin$ inflation reuires $overn&ent to take unpopular actions like reducin$ spendin$or raisin$ ta-es, while traditional fiscal policy solutions to fi$htin$ une&ploy&ent tend tobe &ore popular since they reuire increasin$ spendin$ or cuttin$ ta-es# Politicalrealities, in short, &ay favor a bi$$er role for &onetary policy durin$ ti&es of inflation#.ne other reason su$$ests why fiscal policy &ay be &ore suited to fi$htin$une&ploy&ent, while &onetary polic y &ay be &ore effective in fi$htin$ inflation# Thereis a li&it to how &uch &onetary policy can do to help the econo&y durin$ a period ofsevere econo&ic decline, such as the 0tates encountered durin$ the 19;s# The &onetarypolicy re&edy to econo&ic decline is to increase the a&ount of &oney in circulation,thereby cuttin$ interest rates# But once interest rates reach Fero, the Ded can do no &ore#The ?nited 0tates has not encountered this situation, which econo&ists call the Oliuiditytrap,O in recent years, but Lapan did durin$ the late 199;s# 6ith its econo&y sta$nant andinterest rates near Fero, &any econo&ists ar$ued that the Lapanese $overn&ent had toresort to &ore a$$ressive fiscal policy, if necessary runnin$ up a siFable $overn&entdeficit to spur renewed spendin$ and econo&ic $rowth#
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