Monetary, Banking and FinancialDevelopments in India

1947-48 to 2009-10Incorporating

• A Comprehensive Description and Review, of the Post-Independence Evolution andPresent Structure of India's Monetary System, Banking Institutions and Financial Marketswith Focus on Post-1991 Developments

• The Major Areas Covered Include: Monetary Policy and Monetary Management, CreditPolicy, Reserve Bank of India (RBI), Commercial Banks, Co-operative Banks,Development Finance Institutions (DFIs), Non-banking Financial Companies (NBFCs),Mutual Funds, Money Market, Government Securities Market, Capital Market, InsuranceMarket and Foreign Exchange Market

• Global Financial Crisis and the Indian Economy

• Summary of Monetary Policy Statement of the RBI for the Year 2009-10

• Summary of Developmental and Regulatory Policies of the RBI for the Year 2009-10

• Policy Measures by the RBI from September 2008 to March 2009 to Mitigate the AdverseImpact of Global Economic Crisis on the Indian Economy

• Annual Review of Money and Prices in India: 1947-48 to 2008-09

• Annual Review of Banking and Financial Developments in India: 1947-48 to 2008-09

• Glossary of Money, Banking and Financial Terms

By

Niti BhasinSenior Lecturer, Department of Commerce

Delhi School of EconomicsUniversity of Delhi

NEW

NCIENTUIT

New Century PublicationsNew Delhi, India

Contents

Author's Note on the Book vii-xxxii

Part I: Money, Monetary Policy and Reserve Bank of India

1. Money and Monetary Policy. 1 -261.1 Forms of Money

1.1.1 Fiat Money versus Fiduciary Money1.1.2 Electronic Money (E-money)

1.2 Functions of Money %

1.3 Monetary Management by Central Banks1.3.1 History of Central Banks1.3.2 Changing Objectives of Central Banks1.3.3 Central Banks in Developed and Developing Countries1.3.4 Functions of a Central Bank

1.4 Monetary Policy Objectives1.5 Monetary Policy versus Fiscal Policy1.6 Globalisation and Monetary Policy

2. Reserve Bank of India and Monetary Management 27-642.1 Establishment and Early History of RBI2.2 Pre-Independence Activities of RBI2.3 Functions of RBI

2.3.1 Sole Currency Authority2.3.2 Banker to the Governments2.3.3 Bankers' Bank and Lender-of-the-last-resort2.3.4 Controller of Money and Credit2.3.5 Controller of Foreign Exchange2.3.6 Source of Economic Information2.3.7 Promotional Role of RBI

2.4 Post-Independence Review of the Role and Responsibilities of RBI2.4.1 Partition, Disruption and Devaluation2.4.2 Nationalisation of RBI in 19492.4.3 Five Year Plans and the RBI2.4.4 RBI as Institution Builder2.4.5 Nationalisation of Banks in 1969 and 1980

xl Monetary, Banking and Financial Developments in India

2.4.6 Sukhamoy Chakravarty Committee and MonetaryPolicy Initiatives during the 1980s

2.5 Post-1991 Reforms and Responsibilities of RBI2.5.1 Financial Sector Reforms2.5.2 External Sector Reforms2.5.3 Deregulation of Interest Rates2.5.4 Short-term Liquidity Management2.5.5 Payment and Settlement Systems -2.5.6 Regulation and Supervision

2.6 Measures of Money, Supply in India2.7 Electronic Money (E-money) in India

2.7.1 Recommendations of the Working Group onElectronic Money (Chairman: Zaire J. Camas), 2002

2.8 Monetary Transmission Mechanism2.9 Monetary Policy-Fiscal Policy Interface in India2.10 Conclusion

3. Monetary Policy and Prices 65-813.1 Relationship between Money and Prices3.2 Definition and Measurement of Price Rise3.3 Need to Monitor and Moderate Price Rise3.4 Causes of Price Rise

3.4.1 Excess of Demand3.4.2 Lack of Supply3.4.3 Other Factors

3.5 Effects of Price Rise3.6 Determinants of Price Policy3.7 Constituents of Price Policy

3.7.1 Fiscal Policy3.7.2 Monetary Policy3.7.3 Commercial Policy

3.8 Role of Buffer Stock Operations3.9 History of Price Controls in India3.10 Price Stability as an Objective of Monetary Policy in India3.11 Price Policy of the Government

3.11.1 Demand Side3. VT2 Supply Side

3.12 Fiscal Deficits, Monetary Expansion and Price Rise3.13 Conclusion

Contents , xli

4. Monetary Policy Reforms Since 1991 82-994.1 Economic Reforms and Monetary Management4.2 Constituents of Monetary Reforms

4.2.1 Ways and Means Advances (WMA) Replace Treasury Bills4.2.2 Reactivation of the Bank Rate4.2.3 Deregulation of Interest Rate4.2.4 Deregulation of Credit

4.3 RBI's Internal Group on Liquidity Adjustment Facility (LAF)4.3.1 Recommendations Regarding Day-to-day

Liquidity Management4.3.2 Recommendations Regarding Sterilisation

4.4 Changing Monetary Policy Paradigm in India4.5 Recent Challenges %

4.6 Operating Procedures of Monetary Policy4.6.1 Liquidity Adjustment Facility (LAF)4.6.2 Market Stabilization Scheme

4.7 External Sector Openness and Conduct of Monetary Policy4.8 Monetary Policy Assessment

5. Credit Policy 100-1065.1 Significance of Credit Policy5.2 Credit Policy in India

5.2.1 Allocation of Credit between Government and thePrivate Sector

5.2.2 Inter-sectoral Allocation of Institutional Credit5.2.3 Inter-regional Allocation of Credit

5.3 Flow of Credit to Agricultural Sector5.3.1 Advisory Committee on the Flow of Credit to

Agriculture and Related Activities from the BankingSystem (Chairman: V.S. Vyas), 2004

5.4 NABARD and the Co-operative Sector5.4.1 Credit Extended by NABARD

5.5 Agriculture Credit in the 2006-07 Union Budget

Part II: Commercial Banks and otherFinancial Intermediaries

6. Commercial Banks 107-2026.1 Meaning and Role of Commercial Banks

xlii Monetary, Banking and Financial Developments in India

6.2 Functions of a Commercial Bank6.3 Balance Sheet of a Commercial Bank

6.3.1 Liabilities of a Bank6.3.2 Assets of a Bank

6.4 Classification of Commercial Banks in India6.4.1 Scheduled and Non-scheduled Banks6.4.2 Indian and Foreign Banks6.4.3 Public Sector and Private Sector Banks6.4.4 Regional Rural Banks -

6.5 Pre-Independence History of Commercial Banks in India6.5.1 Presidency Banks6.5.2 Paper Currency Act, 18616.5.3 Banking Crisis, 19136.5.4 Reserve Bank of India Act, 19346.5.5 Indian Companies (Amendment) Act, 19366.5.6 Bank Failures and Remedial Measures6.5.7 Regulation and Supervision

6.6 Post-Independence Developments in Commercial Banking6.6.1 Pre-nationalisation Period6.6.2 Post-nationalisation Period

6.7 Banking Sector Reforms since 19916.7.1 What Triggered Banking Sector Reforms?6.7.2 Objectives of Banking Sector Reforms6.7.3 Contents of Banking Sector Reforms

6.8 Credit Flow from the Banking System: Sector-wise Review6.8.1 Credit to Agriculture and Allied Activities6.8.2 Credit Flow to Small-scale and Medium Industries6.8.3 Export Credit

6.9 Regulation and Supervision of Commercial Banks6.9.1 Need for Regulation and Supervision6.9.2 Regulatory and Supervisory Policy during the 1950s6.9.3 Regulatory and Supervisory Policy during the 1960s6.9.4 Nationalisation of Banks and Shift in Focus6.9.5 Regulatory and Supervisory Policy during the 1980s6.9.6 Post-liberalisation Period (1991 onwards)

6.10 Recent Initiatives Concerning Commercial Banks6.10.1 Strengthening of Prudential Framework6.10.2 Road Map for Foreign Banks in India6.10.3 Payment of Dividends

Contents xliii

6.10.4 Managerial Autonomy for Public Sector Banks6.10.5 Mergers and Amalgamation of Banks6.10.6 Restructuring Regional Rural Banks (RRBs)6.10.7 Exposure Norms6.10.8 Implementation of the New Capital Adequacy Framework

(Basel II norms)6.10.9 Income Recognition, Asset Classification and Provisioning6.10.10 Investment Norms v ~-"6.10.11 Capital Adequacy-Norms6.10.12 Transparency and Disclosures6.10.13 Securitisation of Standard Assets6.10.14 Management of NPAs by Banks6.10.15 Anti-Money Laundering Guidelines6.10.16 Customer Service6.10.17 Banking Codes and Standards Board of India6.10.18 Remittance Facility to NRIs/PIOs6.10.19 Shifting of Branches/Offices: Procedural Rationalisation6.10.20 Board for Financial Supervision6.10.21 Implementation of Risk Based Supervision (RBS)6.10.22 Off-site Monitoring and Surveillance6.10.23 Supervision of Financial Conglomerates6.10.24 Credit Information Bureau of India Ltd. (CIBIL)6.10.25 Monitoring of Frauds6.10.26 Outsourcing by Banks6.10.27 Compliance Function

6.11 Indian Banking and Modern Technology6.11.1 Information Technology6.11.2E-Banking6.11.3 Ensuring e-security

6.12 Current Issues in Indian Banking6.12.1 Effective Implementation of Basel II Framework and

Migration to Advanced Approaches6.13 Summing up

7. Co-operative Banks 203-2287.1 Introduction7.2 Classification of Co-operative Banks

7.2.1 Urban Co-operative Banks (UCBs)7.2.2 Rural Co-operatives

xliv Monetary, Banking and Financial Developments in India

7.3 Urban Co-operative Banks (UCBs): Recent Policy Initiatives7.3.1 Vision Document and Medium-Term

Framework (MTF) for UCBs7.3.2 Strengthening of the Supervisory System Related to UCBs7.3.3 Know Your Customer (KYC) Guidelines7.3.4 Priority Sector Lending7.3.5 Mergers/Amalgamations of UCBs7.3.6 Relaxation of Investment Portfolios of UCBs7.3.7 Disclosure Norms7.3.8 Restructuring of Scheduled UCBs with Negative Net Worth

7.4 Rural Co-operatives: History and Recent Policy Measures7.4.1 Asset Classification for State Government Guaranteed Advances7.4.2 Additional Provisioning Requirement for NPAs7.4.3 Task Force on Revival of Rural Co-operative Credit Institutions

(Chairman: A. Vaidyanathan), 20057.4.4 Prudential Guidelines on Agricultural Advances7.4.5 Inspections7.4.6 Management of Co-operatives

7.5 Primary Agricultural Credit Societies (PACS)7.6 Micro Credit Programme

7.6.1 Graduation of Mature SHGs into Micro-enterprises7.6.2 Micro-finance and the Government7.6.3 Micro-finance and the RBI

7.7 Kisan Credit Cards7.8 NABARD and the Co-operative Sector

7.8.1 Resources of NABARD7.8.2 Rural Infrastructure Development Fund (RIDF)7.8.3 Credit Extended by NABARD7.8.4 Interest Rates charged by NABARD

7.9 Summing up

8. Development Finance Institutions (DFIs) 229-2438.1 Introduction8.2 All-India Financial Institutions (AIFIs)

8.2.1 All-India Development Banks8.2.2 Specialised Financial Institutions8.2.3 Investment Institutions8.2.4 Refinance Institutions

8.3 State Level Institutions

Contents xlv

8.4 Working Group for Harmonising the Role and Operations ofDevelopment Finance Institutions (DFIs) and Banks(Chairman: S.H. Khan), 1998

8.5 Development Finance Institutions (DFIs): The Changed Scenario8.6 Regulation and Supervision of Financial Institutions8.7 Recent Policy Initiatives Regarding DFIs8.8 Conclusion

9. Non-banking Financial Companies (NBFCs) 244-2509.1 Meaning and Importance of NBFCs9.2 Regulation and Supervision of NBFCs)

9.2.1 Guidelines for Mergers/Amalgamations9.3 NBFCs in Insurance Business9.4 Policy Initiatives Regarding NBFCs in Recent Years9.5 Conclusion

10. Mutual Funds 251-25410.1 Introduction10.2 Bifurcation of UTI10.3 Role of Mutual Funds in the Stock Market

Part III: Financial System and Financial Markets

11. Financial System and Economic Development 255-26011.1 Meaning and Importance of Financial System11.2 Emerging Financial Paradigm

11.2.1 From Financial Neutrality to Financial Activism11.2.2 From Financial Volatility to Financial Stability11.2.3 Role of the Government in Financial Development

12. Financial System of India: An Overview 261-29212.1 Pre-Independence Financial System12.2 Post-Independence Developments

12.2.1 Nationalisation of Imperial Bank of India (1955)12.2.2 Nationalisation of Life Insurance Business (1956)12.2.3 Nationalisation of Commercial Banks (1969 and 1980)12.2.4 Nationalisation of General Insurance Business (1973)12.2.5 Rethinking on Government Domination of Financial Sector

xlvi Monetary, Banking and Financial Developments in India

12.2.6 From Financial Repression to FinancialLiberalisation (1991 onward)

12.2.7 India's Approach to Financial Sector Reforms12.2.8 Strategy of Financial Sector Reforms12.2.9 Achievements and Areas of Concern

12.3 Reserve Bank of India (RBI): New Role12.4 Recent Initiatives to Strengthen Financial System

12.4.1 Payment and Settlement Systems ""12.4.2 Technological Developments12.4.3 Legal Reforms12.4.4 Consultative Process in Policy Formulation12.4.5 International Security Standards12.4.6 Migration to Basel II Norms'

12.5 Future of India's Financial Sector12.5.1 Vision Document for Payment Systems, 2005-0812.5.2 Financial Sector Technology Vision Document12.5.3 Road Map for Foreign Banks in India

12.6 Conclusion

13. Money Market 293-31013.1 Meaning and Functions of Money Market13.2 Reserve Bank of India (RBI) and the Money Market13.3 Evolution of Money Market in India

13.3.1 Pre-Independence Period13.3.2 Post-Independence Period

13.4 Developments in the Money Market since 199113.5 Components-wise Analysis of Money Market in India

13.5.1 Call/Notice Money Market13.5.2 Commercial Paper (CP)13.5.3 Certificates of Deposit (CDs)13.5.4 Repos

13.6 Report of the Technical Group on Money Market13.6.1 Follow-up Action

13.7 Areas of Concern13.8 Conclusion

14. Government Securities Market 311 -31914.1 Introduction

14.1.1 RBI and the Government Securities Market

Contents xlvii

14.2 Evolution of Government Securities Market14.3 Post-1991 Measures to Promote Government Securities Market

14.3.1 Fiscal Responsibility and Budget Management(FRBM) Act, 2003

14.3.2 Technical Group on Central Government SecuritiesMarket, 2005

14.3.3 Negotiated Dealing System (NDS)14.3.4 Institutional Initiatives " —14.3.5 Measures to Improve Market Functioning14.3.6 Other Measures

14.4 Challenges for the Future14.5 Conclusion

15. Capital Market 320-33115.1 Meaning and Importance

15.1.1 Stock Market15.2 Capital Market in the Pre-reforms (i.e. Pre-1991) Period

15.2.1 Establishment of Securities and ExchangeBoard of India (SEBI)

15.3 Reforms in the Capital Market since 199115.3.1 New Capital Issues: Introduction of Free Pricing15.3.2 Disclosure Norms15.3.3 Transparency and Efficiency15.3.4 Shortening of Settlement Cycle15.3.5 Strengthening Regulatory Framework15.3.6 Derivatives Market15.3.7 Other Reforms

15.4 Portfolio Investment Flows: Global and Indian Experiences15.5 Capital Market in the 2007-08 Union Budget15.6 Conclusion

16. Insurance Market 332-3441.6.1 Nationalisation of Insurance Business in India after Independence16.2 Weaknesses of Insurance Industry Prior to Reforms of Late 1990s

16.2.1 Low Productivity16.2.2 Lack of Information Technology16.2.3 Limited Availability of Insurance Products16.2.4 Poor Quality of Insurance Services

16.3 Committee on Reforms in Insurance Sector

xlviii Monetary, Banking and Financial Developments in India

(Chairman: R. N. Malhotra), 199416.4 Indian Insurance Business: Towards Competition16.5 Regulations and Controls16.6 Post-liberalisation Developments in Indian Insurance Business

16.6.1 New Initiatives16.6.2 From Monopolistic Exploitation to

Customer-friendly Products16.6.3 Flexibility of Unit-linked Products16.6.4 Pension Schemes16.6.5 Participation of Banks in Insurance Business16.6.6 Rising Service Levels

16.7 Towards a Broad-based Insurance Sector16.7.1 Commercial Banks in Insurance Business16.7.2 Non-banking Financial Companies (NBFCs) in

Insurance Business16.7.3 Co-operative Credit Institutions in Insurance Business

16.8 FDI in the Insurance Sector16.9 Conclusion

17. Foreign Exchange Market 345-36817.1 Introduction17.2 Evolution of Foreign Exchange Regulation/Management in India

17.2.1 Pre-Independence Period17.2.2 Post-Independence Period

17.3 Foreign Exchange Policy Initiatives since 199117.3.1 Rupee Rate Adjustment17.3.2 Introduction of Liberalised Exchange Rate Management

System (LERMS)17.3.3 Current Account Convertibility17.3.4 Capital Account Convertibility (CAC)17.3.5 Foreign Exchange Exposure Norms of Commercial Banks17.3.6 Foreign Exchange Reserves17.3.7 Technical Group on Foreign Exchange Market, 2005

17.4 Conclusion

Part IV: Global Financial Crisis and the Indian Economy

18. Capitalism and Business Cycles: History and Views 369-37818.1 Views of Classical Economists

Contents xlix

18.2 The Great Depression18.3 Keynesian Economics18.4 Modes of State Intervention

18.4.1 Direct Intervention18.4.2 Indirect Intervention

18.5 Contagious Nature of Business Cycles

19. India's Response to Global Meltdown 379-39419.1 Period Preceding the Present Crisis19.2 Genesis of the Present Crisis

19.2.1 Ninja Loans19.3 Damage Control Measures19.4 Contagious Nature of Crisis and the Rejection of

De-coupling Theory19.4.1 Inter-sectoral Contagion19.4.2 Inter-country Contagion

19.5 Intensity of the Crisis19.6 Impact of Present Crisis on India

19.6.1 Impact on Indian Financial System19.6.2 Slump in Indian Stock Market19.6.3 Cash/Liquidity Crunch in Domestic Money Market19.6.4 Depreciating Rupee vis-a-vis Dollar

19.7 Government's Policy to Deal with the Crisis19.8 Remedial Measures Taken by the Government

19.8.1 Measures to Boost Demand19.8.2 Measures to Boost Exports19.8.3 Measures to Contain Price Rise19.8.4 Deviation from Fiscal Consolidation

19.9 Remedial Measures Taken by the Reserve Bank of India (RBI)19.9.1 Measures to Rupee Liquidity/Credit Delivery19.9.2 Measures to Encourage Flow of Credit to

Hard-pressed/Priority Sectors19.9.3 Measures Aimed at Managing Forex Liquidity/Modulate

Exchange Rate Movements19.9.4 Measures Aimed at Export Promotion

19.10 Measures Taken by Securities and Exchange Board of India (SEBI)19.11 Outlook for India

19.11.1 Positive Factors19.11.2 Negative Factors