Changing role of RBI in the financial Sector

6th February 2021 0 By indiafreenotes

The Reserve Bank of India (RBI) is the central bank for India. The RBI handles many functions, from handling monetary policy to issuing currency. India has reported some of the best gross domestic product (GDP) growth rates in the world. It is also known as one of the four most powerful emerging market countries, collectively part of BRIC nations, which include Brazil, Russia, India, and China.

Prior to liberalization RBI used to regulate and control the financial sector that includes financial institutions like commercial banks investment banks stock exchange operations and foreign exchange market. With the economic liberalization and financial sector reforms RBI needed to shift its role from a controller to facilitator of the financial sector. This implies that the financial organisations were free to make their own decisions on many matters without consulting the RBI. This opened up the gates of financial sectors for the private players. The main objective behind the financial reforms was to encourage private sector participation increase competition and allowing market forces to operate in the financial sector. Thus it can be said that before liberalization RBI was controlling the financial sector operations whereas in the post-liberalization period the financial sector operations were mostly based on the market forces.

The International Monetary Fund (IMF) and World Bank have highlighted India in several reports showing its high rate of growth. In April 2019, the World Bank projected India’s GDP growth would expand by 7.5% in 2020.1 Also in April 2019, the IMF showed an expected GDP growth rate of 7.3% for 2019 and 7.5% for 2020.2 Both projections have India with the highest expected GDP growth in the world over the next two years.

As with all economies, the central bank plays a key role in managing and monitoring the monetary policies affecting both commercial and personal finance as well as the banking system. As GDP moves higher in the world rankings the RBI’s actions will become increasingly important.

In April 2019, the RBI made the monetary policy decision to lower its borrowing rate to 6%.3 The rate cut was the second for 2019 and is expected to help impact the borrowing rate across the credit market more substantially.4 Prior to April, credit rates in the country had remained relatively high, despite the central bank’s positioning, which has been limiting borrowing across the economy.

The central bank must also grapple with a slightly volatile inflation rate that is projected at 2.4% in 2019, 2.9% to 3% in the first half of 2020, and 3.5% to 3.8% in the second half of 2020.

The RBI also has control over certain decisions regarding the country’s currency. In 2016, it affected a demonetization of the currency, which removed Rs. 500 and Rs. 1000 notes from circulation, mainly in an effort to stop illegal activities. Post analysis of this decision shows some wins and losses. The demonetization of the specified currencies caused cash shortages and chaos while also requiring extra spending from the RBI for printing more money.

Quantitative measures:

It refers to those measures of RBI in which affects the overall money supply in the economy. Various instruments of quantitative measures are:

  • Bank rate: it is the interest rate at which RBI provides long term loan to commercial banks. The present bank rate is 6.5%. It controls the money supply in long term lending through this instrument. When RBI increases bank rate the interest rate charged by commercial banks also increases. This, in turn, reduces demand for credit in the economy. The reverse happens when RBI reduces the bank rate.
  • Liquidity adjustment facility: it allows banks to adjust their daily liquidity mismatches. It includes a Repo and reverse repo operations.
  • Repo rate: Repo repurchase agreement rate is the interest rate at which the Reserve Bank provides short term loans to commercial banks against securities. At present, the repo rate is 6.25%.
  • Reverse repo rate: It is the opposite of Repo, in which banks lend money to RBI by purchasing government securities and earn interest on that amount. Presently the reverse repo rate is 6%.
  • Marginal Standing Facility (MSF): It was introduced in 2011-12 through which the commercial banks can borrow money from RBI by pledging government securities which are within the limits of the statutory liquidity ratio (SLR). Presently the Marginal Standing Facility rate is 6.5%.

Market stabilisation scheme (MSS): this instrument is used to absorb the surplus liquidity from the economy through the sale of short-dated government securities. The cash collected through this instrument is held in a separate account with the Reserve Bank. It was introduced in 2004. RBI had raised the ceiling of the market stabilisation scheme after demonetization in 2016.

Every Central Bank has to perform numerous promotional and development functions which vary from country to country. This is truer in a developing country like India where RBI has been performing the functions of the promoter of financial system along with several special functions and non-monetary functions.

  • Promotion of Banking habits and expansion of banking system: It performs several functions to promote banking habits among different sections of the society and promotes the territorial and functional expansion of banking system. For this purpose, RBI has set several Institutions such as Deposit and Insurance Corporation 1962, the agricultural refinance Corporation in 1963, the IDBI in 1964, the UTI in 1964, the Investment Corporation of India in 1972, the NABARD in 1982, and national housing Bank in 1988 etc.
  • Export promotion through refinance facility: RBI promotes export through the Export Credit and Guarantee Corporation (ECGC) and EXIM Bank. It provides refinance facility for export credit given by the scheduled commercial banks. The interest rate charged for this purpose is comparatively lower. ECGC provides insurance on export receivables whereas EXIM banks provide long-term finance to project exporters etc.
  • Development of financial system: RBI promotes and encourages the development of Financial Institutions, financial markets and the financial instruments which is necessary for the faster economic development of the country. It encourages all the banking and non-banking financial institutions to maintain a sound and healthy financial system.
  • Support for Industrial finance: RBI supports industrial development and has taken several initiatives for its promotion. It has played an important role in the establishment of industrial finance institutions such as ICICI Limited, IDBI, SIDBI etc. It supports small scale industries by ensuring increased credit supply. Reserve Bank of India directed the commercial banks to provide adequate financial and technical assistance through specialised Small-Scale Industries (SSI) branches.
  • Support to the Cooperative sector: RBI supports the Cooperative sector by extending indirect finance to the state cooperative banks. It routes this finance mostly via the NABARD.
  • Support for the agricultural sector: RBI provides financial facilities to the agricultural sector through NABARD and regional rural banks. NABARD provides short term and long-term credit facilities to the agricultural sector. RBI provides indirect financial assistance to NABARD by providing large amount of money through General Line of Credit at lower rates.
  • Training provision to banking staff: RBI provides training to the staff of banking industry by setting up banker s training college at many places. Institutes like National Institute of Bank management (NIBM), Bank Staff College (BSC) etc. provide training to the Banking staff.
  • Data collection and publication of reports: RBI collects data about interest rates, inflation, deflation, savings, investment etc. which is very helpful for researchers and policymakers. It publishes data on different sectors of the economy through its Publication division. It publishes weekly reports, annual reports, reports on trend and progress of commercial bank etc.