Indian Economy, 5th edition (58 page)

Banks can borrow through MSF on all working days except Saturdays, between 3.30 and 4 30 pm in Mumbai where RBI has its headquarters. The minimum amount which can be accessed through MSF is Rs.1 crore and in multiples of Rs.1 crore.

MSF represents the upper band of the interest corridor and reverse repo (7.25 per cent) as the lower band and the repo rate in the middle. To balance the liquidity, RBI would use the sole independent policy rate which is the repo rate and the MSF rate automatically adjusts to 1 per cent above the repo rate.

Similar to India’s MSF the ECB (European Central Bank) also offers standing facilities called
marginal lending facilities
(MLF) and the Federal Reserve (the US Central Bank) has
discount window systems
(DWS). Like the MSF, the secondary credit facility made available by the Federal Reserve to the depository institutions in USA is typically overnight credit on a very short term basis at rates above the primary credit rate.

The effectiveness of standing facilities in reducing volatility have been examined by many scholars and certain studies have pointed out that in the Federal Reserve System in the United States, the design of the facility decreases a bank’s incentive to participate actively in
interbank market
(i.e. India’s Call Money Market) due to the perceived stigma from using such facility. This in turn reduces the effectiveness of standing facility in reducing interest rate volatility.

Bank Rate realigned with MSF

The RBI on February 15, 2012 increased the Bank Rate by 350 basis points from 6 per cent to 9.50 per cent and realigned the Bank Rate with Marginal Standing Facility (MSF) rate, which, in turn, is linked to the policy repo rate
15
. Henceforth, whenever there is an adjustment of the MSF rate, the RBI will consider and align the Bank Rate with the revised MSF rate.

Being the discount rate, the Bank Rate should technically be higher than the policy repo rate. The Bank Rate has, however, been kept unchanged at 6 per cent since April 2003. This was mainly for the reason that monetary policy signalling was done through modulations in the reverse repo rate and the repo rate till May 3, 2011, and the policy repo rate under the revised operating procedure of monetary policy from May 3, 2011 onwards.

Moreover, under the revised operating procedure, MSF, instituted at 100 basis points above the policy repo rate, has been in operation, which more or less served the purpose of the Bank Rate. At present, the repo rate is 8.50 per cent, reserve repo 7.50 per cent and MSF 9.50 per cent. Repo rate is the rate at which banks borrow funds from the RBI and reverse repo rate is the rate at which banks park their funds with the RBI. Under the MSF, banks are permitted to avail themselves of funds from the RBI on overnight basis.

The Bank Rate acts as the
penal rate
charged on banks for shortfalls in meeting their reserve requirements (CRR and SLR)). The Bank Rate is also used by several financial institutions as a reference rate for indexation purposes.

BASE RATE

Base Rate is the interest rate below which Scheduled Commercial Banks (SCBs) will lend no loans to its customers - its means it is like Prime Lending Rate (PLR) and the Benchmark Prime lending Rate (BPLR) of the past and is basically a floor rate of interest. It replaced
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the existing idea of BPLR on July 1, 2010.

The BPLR system (while the existing system was of PLR), introduced in 2003, fell short of its original objective of
bringing transparency
to lending rates. This was mainly because under this system, banks could lend below BPLR.This made a bargaining by the borrower with bank- ultimately one borrower getting cheaper loan than the other, and blurred the attempts of bringing in transparency in the lending business. For the same reason, it was also difficult to assess the transmission of
policy rates
(i.e. repo rate, reverse repo rate, bank rate) of the Reserve Bank to lending rates of banks. The Base Rate system is
aimed at
enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary policy. To look into this matter the RBI constituted a Working Group on Benchmark Prime Lending Rate (chaired Deepak Mohanty) to review the present benchmark prime lending rate (BPLR) system and suggest changes to make credit pricing more transparent- report submitted in October 2009 and accordingly the idea of Base rate was implemented.

Now, all categories of loans are priced with reference to the Base Rate only, except the- (a) Differential rate of Interest ( DRI) loans (b) loans to banks’ own employees, and (c) loans to banks’ depositors against their own deposits. Since the Base Rate will be the minimum rate for all loans, banks are not permitted to resort to any lending below this rate- accordingly, the provision of lending below the BPLR to a customer by banks if the loan amount is not less than Rs. 2 lakh has been withdrawn. It is expected that the above
deregulation
of lending rate will increase the credit flow to small borrowers at reasonable rate and direct bank finance will provide effective competition to other forms of high cost credit. For export credit, RBI announces the floor rate, separately. Banks are required to review the Base Rate at least once in a quarter and publish the same for the general public.

Current Credit & Monetary Policy

As per the
Annual Monetary Policy Statement 2013-14 of the RBI
(announced on 3rd May, 2013) the key rates of the Credit & Monetary Policy stands as given below –

1.
Policy Rates:

Bank Rate –                         8.25%

Repo Rate –                         7.25%

Reverse Repo Rate –            6.25%

Marginal Standing
Facility Rate –                      8.25%

2.
Reserve Ratios:

Cash Reserve Ratio –           4%

Statutory Liquidity Ratio –    23%

3.
Lenidng / Deposit Rates:

Base Rate –                         9.70%- 10.25%

Saving Deposit Rate –          4.0% (relates to 5 major banks)

Term Deposit Rate –            7.5% - 9.00%

As the ‘headline inflation’ rate of India is presently (
April 15, 2013
) at a
three-year low
of 5.96 per cent (in Dec. 2009, it was at 4.95 per cent) the business and industry in the country is hopeful of cuts in the CRR as well as the Repo rate by the RBI when the Central bank announces its
Annual Policy Statement,
end-May, 2013. Experts together with the major bankers of the country also believe this action imminent from the RBI as the slackening growth rate of the economy needs some ‘boosting’ from the interest rate side.

Nationalisation and
Development of Banking

The development of banking industry in India has been intertwined with the story of its nationalisation. Once the Reserve Bank of India (RBI) was nationalised in 1949 and a central banking was in place the government considered the nationalising of selected private banks in the country due to the following
major
reasons:

(i)
As the banks were owned and managed by the private sector the services of the banking were having a narrow reach—the masses had no access to the banking service;

(ii)
The Government needed to direct the resources in such a way that greater public benefit could take place;

(iii)
The planned development of the economy required a certain degree of government control on the capital generated by the economy. Nationalisation of banks in India took place in the following two stages:

1. Emergence of the SBI

The Government of India, with the enactment of the
SBI Act, 1955
partially nationalised
the three Imperial Banks (mainly operating in the three Presidencies of past with their 466 branches) and named them the State Bank of India—the first public sector bank emerged in India. The RBI had purchased 92 per cent of the shares in this partial nationalisation.

Satisfied with the experiment, the Government in a related move
partially nationalised
eight more private banks (with good regional presence) via
SBI (Associates) Act, 1959
and named them as the Associates of the SBI—the RBI had acquired 92 per cent stake in them as well. After merging the State Bank of Bikaner and the State Bank of Jaipur as well, the RBI came up with the
s
tate Bank of Bikaner and Jaipur. Now the SBI Group has a total number of Six banks—SBI being one and Five of its Associates.

2. Emergence of Nationalised Banks

After successful experimentation in the partial nationalisations the Government decided to go for complete nationalisation. With the help of the
Banking Nationalisation Act, 1969,
the Government nationalised a total number of 20 private banks:

(i)
14 banks with deposits more than
`
50 crore nationalised in July 1969, and

(ii)
6 banks with deposits more than
`
200 crore nationalised in April 1980.

After the merger of the loss-making New Bank of India with the Punjab National Bank (PNB) in September 1993, the total number of the nationalised banks came down to 19. Today, there are 27 public sector banks in India out of which 19 are nationalised (though none of the so-called nationalised banks have 100 per cent ownership of the Government of India).

After the nationalisation of banks the Government
stopped
opening of banks in the private sector though some foreign private banks were allowed to operate in the country to provide the external currency loans. After India ushered in the era of the economic reforms, the Government started a comprehensive banking system reform in the fiscal 1992–93. Three related developments allowed the further expansion of banking industry in the country:

(i)
In 1993 the SBI was allowed access to the capital market with permission given to sell its share to the tune of 33 per cent through
SBI (Amendment) Act, 1993
.

At present the Government of India has 59.73 per cent shares in the SBI (
It was on July 9, 2007 that the entire equity stake of RBI was taken over by the Government of India. Thus, the RBI is no more the holding bank of the SBI and its Associates
.).

On October 10, 2007 the Government announced its proposal of selling the shares of the SBI and cutting down its stake in it to 53 per cent level so that the bank can go for capitalisation.

(ii)
In 1994 the Government allowed the nationalised banks to have the access to the capital market with a ceiling of 33 per cent sale of shares through the
Banking Companies (Amendment) Act, 1994
.

Since then many nationalised banks have tapped the capital market for their capital enhancement—Indian Overseas Bank being the first in the row. Though such banks could be better called the public sector banks (as the GoI holds more than 50 per cent stake in them) they are still known as the nationalised banks.

(iii)
In 1994 itself the Government allowed the opening of private banks in the country. The first private bank of the reform era was the UTI Bank. Since then a few dozens Indian and foreign private banks have been opened in the country.

Thus, since 1993–94 onwards, we see a reversal of the policies governing banks in the country. As a general principle, the public sector and the nationalised banks are to be converted into private sector entities. What would be the minimum government holding in them is still a matter of debate and yet to be decided.
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The policy of bank consolidation is still being followed by the government, so that these banks could broaden their capital base and emerge as significant players in the global banking competition.
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Every delay in it will hamper their interests, as per the experts.

3. Emergence of the RRBs

The Regional Rural Banks (RRBs) were first set up on October 2, 1975 (only 5 in numbers) with the aim
to take banking services to the doorsteps of the rural masses specially in the remote areas with no access to banking services with twin duties
to fulfill:

(i)
to provide credit to the weaker sections of the society at concessional rate of interest who previously depended on private money lending and

(ii)
to mobilise rural savings and channelise them for supporting productive activities in the rural areas.

Following the suggestions of the
Kelkar Committee
, the government stopped opening new RRBs in 1987 – by that time their total number stood at 196. Due to excessive leanings towards social banking and catering to the highly economically weaker sections, these banks started incurring huge losses by early 1980s. For restructuring and strengthening of the banks, the governments set up two committees – the
Bhandari Committee
(1994–95) and the
Basu Committee
(1995–96). Out of the total, 171 were running in losses in 1998–99 when the government took some serious decisions
:

(i)
the obligation of concessional loans abolished and the RRBs started charging commercial interest rates on its lendings.

(ii)
the target clientele (rural masses, weaker sections) was set free now to lend to any body.

After the above-given policy changes, the RRBs started coming out of the red/losses. The CFS has recommended to get them merged with their managing nationalised or public sector banks and finally make them part of the would-be three-tier banking structure of India. At present there are 82 RRBs (46 amalgamated and 36 standalone) functioning in India even though the amalgamation process is going on (
India 2013
).

Financial Sector Reforms

The process of economic reforms initiated in 1991 had redefined the role of government in the economy—in coming times the economy will be dependent on the greater private participation for its development.
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Such a changed view to development required an overhauling in the investment structure of the economy. Now the private sector was going to demand high investible capital out of the financial system. Thus, an emergent need was felt to restructure the whole financial system of India.