90 years of RBI

SYLLABUS

GS 3 >>> Indian Economy >> Banking

REFERENCE NEWS

In a recent milestone, the Reserve Bank of India has marked its significant 90-year journey. Throughout its history, the central bank has experienced various challenges and successes, showcasing a remarkable trajectory of accomplishments.

ABOUT RESERVE BANK OF INDIA (RBI)

• RBI is the central bank of India.
• It was established on April 1, 1935, per the provisions of the Reserve Bank of India Act, 1934.
• It was originally set up as a private entity in 1935, but it was nationalized in 1949.

OBJECTIVES OF RBI

• To regulate the issue of Bank notes and keeping of reserves to secure monetary stability in India and generally to operate the currency and credit system of the country to its advantage.
• To have a modern monetary policy framework to meet the challenge of an increasingly complex economy,
• To maintain price stability while keeping in mind the objective of growth.

KEY ACCOMPLISHMENTS OF RBI

• Monetary Stability Management: The RBI has implemented a flexible inflation targeting (FIT) strategy, which is reviewed every five years in consultation with the Government of India, to maintain price stability using the Consumer Price Index (CPI) as a guide.
• Regulation of the Financial Sector: It has continually strengthened and updated regulatory measures to bolster the banking sector, introducing frameworks such as the Prompt Corrective Action (PCA) to address Non-performing Assets (NPAs) and ensure the financial health of banks.
• Public Debt Management: The RBI has effectively managed India's public debt, securing low-interest rates for government loans and aiding in the financing of public sector expansion.
• Promotion of Financial Inclusion: The RBI has launched various initiatives aimed at increasing banking access, particularly in rural and remote areas, through measures like new banking licenses, priority sector lending, and the establishment of payment and small finance banks.
• Foreign Exchange Management: Under the Foreign Exchange Management Act of 1999, the RBI manages India's foreign exchange reserves and intervenes in the forex markets to curb volatility and maintain external sector stability.
• Modernization of Payment Systems: The RBI has modernized India’s payment and settlement infrastructure, introducing systems such as Real-Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT), and Unified Payments Interface (UPI) to streamline and secure financial transactions.
• Technological Integration in Banking: The RBI has embraced technology to enhance the efficiency and inclusivity of the financial sector through digital banking and fintech innovations(NPCI,BBPS)
• Regulation of Non-Banking Financial Companies (NBFCs): With the increasing prominence of NBFCs, the RBI has imposed stricter regulations to ensure their stability and reduce systemic risks, focusing on asset-liability management, capital adequacy, and corporate governance.
• Support for Economic Development: Through its monetary and development policies, the RBI has played a pivotal role in stimulating economic growth, employment, and the establishment of specialized financial institutions in sectors like industry, agriculture, and exports.
• Enhancing Public Confidence in Banking: The RBI closely supervises commercial banks and has implemented systems like Deposit Insurance and Credit Guarantee to protect depositor interests and boost confidence in the banking system.

CHALLENGES FACED BY RBI

• Autonomy Issues: The central government can issue directives to the RBI under section 7 of the RBI Act when deemed necessary in the public interest, which has led to instances where the government has influenced RBI's decision-making, especially in monetary policy and regulatory actions.
• Inflation Control: Despite implementing a flexible inflation-targeting framework, controlling inflation remains a tough challenge for the RBI. Factors like the high inflation rate in the food basket and external influences such as global oil prices complicate the task of maintaining stable prices.
• Loan Write-offs and Recovery: The practice of writing off loans has helped banks reduce their Gross Non-performing Assets (GNPA), but this strategy does not solve the underlying issues and raises concerns about the transparency and reliability of financial reporting.
• Financial Stability and Systemic Risks: The RBI continuously works to ensure financial stability and mitigate risks associated with rapid credit growth, interconnectedness of financial institutions, and vulnerabilities in the shadow banking sector. High-profile financial crises in institutions like YES Bank highlight the need for stronger oversight.
• Monetary Policy Transmission: There is often an incomplete transmission of monetary policy, where reductions in policy rates do not fully translate into lower lending rates by banks, due to factors like banking system rigidities and liquidity conditions.
• Digitalization and Cybersecurity: As the banking sector rapidly adopts new technologies, the RBI faces challenges in keeping regulatory frameworks up to date and ensuring robust cybersecurity to protect against threats like hacking and phishing.
• Financial Inclusion and Credit Access: Despite efforts to enhance financial inclusion, significant challenges remain in extending credit, particularly to small and marginalized borrowers. Rural areas frequently lack adequate banking infrastructure and the necessary high-speed internet connectivity to support digital banking, although digital payments are expected to grow significantly, driven by rural adoption.

WAY FORWARD

• Fortifying the Regulatory Framework: Strengthening the supervision and regulation of banks and financial institutions by continuously updating regulatory frameworks to address evolving market conditions and risks. Establishing bodies like the Financial Stability and Development Council (FSDC), as suggested by the Raghuram Rajan committee in 2008, could improve financial stability and coordination among regulators.
• Boosting Financial Inclusion: Implementing strategies to expand access to financial services, particularly in underserved areas, could help achieve broader financial inclusion. Initiatives could include promoting digital payments and innovative delivery mechanisms, as recommended by the Nachiket Mor Committee in 2014.
• Enhancing Monetary Policy Transmission: Improving the mechanisms for transmitting monetary policy changes to lending and borrowing rates across the financial system could help ensure that changes in policy rates effectively influence economic activity.
• Improving Risk Management: Developing robust risk management systems within financial institutions to effectively identify, assess, and manage risks, including credit, liquidity, and cyber risks. The introduction of frameworks like the Insolvency and Bankruptcy Code (IBC) has already begun to address issues related to non-performing assets.
• Promoting Technological Innovations: Encouraging the adoption of new technologies such as fintech, digital banking, and blockchain within the financial sector, while ensuring robust cybersecurity measures are in place to protect data and consumer privacy. The RBI's Regulatory Sandbox (RS) launched in 2019 is a step towards fostering fintech innovation in a controlled environment.
• Increasing Transparency and Communication: Enhancing the clarity and transparency of communications from the RBI to financial institutions and the public can help build better understanding and trust in monetary policy decisions and regulatory changes.
• Capacity Building and Training: Investing in comprehensive training and development programs for RBI staff and stakeholders can enhance expertise in financial regulation, supervision, and technology. Recommendations from the Damodaran Committee on improving customer service in banks also emphasize the importance of training.
• Strengthening Governance and Accountability: Implementing stronger governance structures and accountability mechanisms within the RBI can improve decision-making and operational integrity. Recommendations from the P.J. Nayak Committee on enhancing autonomy and governance in banks are relevant here.
• Enhancing Collaboration and Coordination: Strengthening collaboration with other regulatory bodies, government agencies, and international organizations can help tackle cross-sectoral challenges, promote financial stability, and align with global financial norms. Active participation in international forums like the Financial Stability Board (FSB) and the Bank for International Settlements (BIS) is crucial for this coordination.

PRACTICE QUESTION

Q: Examine the achievements and obstacles encountered by the Reserve Bank of India (RBI). Propose reforms to unleash the full potential of the RBI as a driving force for the vision of Viksit Bharat.(15M,250W)