A

PROJECT REPORT ON

“ROLE OF RBI IN INDIAN FINANCIAL MARKET”

SUBMITTED TO UNIVERSITY OF MUMBAI

IN PARTIAL FULFILLMENT OF REQUIREMENT

FOR THE DEGREE OF

BACHELOR’S OF COMMERCE IN ACCOUNTING AND

FINANCE SUBMITTED BY

KRISH RAKESH MUKADAM

TY BMS

SEMESTER VI

ROLL NO: TMSF23007

UNDER THE GUIDANCE OF

ASST.PROF. MRS. TEENA KODIAN

DNYAN GANGA EDUCATION TRUST DEGREECOLLEGE OF

ARTS, COMMERCE AND SCIENCE

THANE (W)

[2023-24]

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 Dnyan Ganga Education Trust’s
Degree College of Arts, Science & Commerce
Opp.Unnathi Greens, Near Haware Citi, Kasarvadavli, GB Road, Thane West 400615

CERTIFICATE

This is to certify that Mr./Ms. Krish Rakesh Mukadam

has worked and duly completed his/her Project Work for the degree of
Bachelor of Management Studies and his/her project is
entitled,
Role Of RBI In Financial Market under my guidance and supervision .

I further certify that the entire work has been done by the learner under
my guidance and that no part of it has been submitted previously for any
Degree or Diploma of any University.

The facts reported & information presented is true & original to the best of my
knowledge and belief.

Project Guide Course Coordinator External Examiner Principal

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 DECLARATION

I the undersigned Mr./Mrs KRISH RAKESH MUKADAM hereby declare that the work
embodied in this project work titled “ROLE OF RBI IN INDIAN FINANCIAL MARKET”
forms my own contribution to the research work carried out under the guidance of Asst.Prof.
Mrs TEENA KODIAN.

This research work has not been previously submitted to any other university for any other
degree /diploma to this or any other university.
Wherever reference has been made to previous works of others, it has been clearly indicated as
such and included in the bibliography/webliography.

I, here, by further declare that all information of this document has been obtained and presented
in accordance with academic rules and ethical conduct.

Place: Thane KRISH MUKADAM

Date: Roll No.TMSF23007

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 ACKNOWLEDGEMENT

To list who all have helped me is difficult because they are numerous and the depth is so
enormous.

I would like to acknowledge the following as being idealistic channels and fresh dimensions in
the completion of this project.

I take this opportunity to thank The University Of Mumbai for giving me chance to do this
project.

I would like to thank my Principal, Dr. Bhavika Karkera madam for providing the necessary
facilities required for completion of this project.

I take this opportunity to thank our Coordinator Asst. Prof. Mrs SHWETA BAJPAI madam,
for her moral support and guidance.

I would also like to express my sincere gratitude towards my Project Guide Asst. Prof. Mrs
TEENA KODIAN who’s guidance and supervision made the project successful.

Lastly, I would like to thank each and every person who directly or indirectly helped me in the
completion of the project especially my Parents and Peers who supported me throughout my
project.

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A STUDY ON ROLE OF RBI
IN INDIAN FINANCIAL
MARKET

5
 INDEX

SR NO. TOPIC PAGE NO.

1. CHAPTER-1 7-10

2. CHAPTER-2 11-17

3. CHAPTER-3 18-38

4. CHAPTER-4 39-58

5. CHAPTER-5 59-61

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 Chapter-1

BANKING SECTOR IN GLOBAL PERSPECTIVE

1.1 The role of bank in economy

Banking if we equate it with money lending, is perhaps as old as civilization

itself. When money in its modern form was not in existence, people in
order to obtain goods or services offered other goods or services in return.
This barter, a clumsy and inconvenient system in many ways. Nevertheles
s could people and did lend or borrow in the form of specific goods which
they received back or rapid in the same form or any other mutually
acceptable form.
Modern banking is something radically different from mere lending. It is f
ar moresophisticated and complicated. Banking institution today form the
heart of the financial structure of any country, whether it is developed or
developing, rich or poor, advanced or backward in the fields of science and
technology.
In a developing economy the role of banks is more creative and
purposeful than in a developed one. This observation is, however, subject
to the assumption that banks are operating in a free-enterprise economy
and not a totalitarian economy where all factors of production are under
state control and all authority is vested in the state. In such a centrally
planned economy the problem of economic development is relatively
simpler in sense that the course of development is laid out and the
economy is expected to move along that course.
The primary task of banks in a free-enterprise economy is to mobilize the
saving of the people and direct them into productive channels. In a
developing country, where people are not in the habit of depositing their
with banks, the task of creating and spreading the banking
habit and of mobilizing the country’s resources becomes a challenging
one. It is true that finance cannot take the place of real resources. But it is
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not lack of resources alone that retards or hinders the process of
economic development. An equally important cause is the lack
of effective utilization of available resources. It is here that banks play sa
crucial role because they act as a bridge between those who require
finance(which enables them to acquire the necessary resources) and those
who have finance(in the form of savings) but are unable to make an
effective and productive use of it. Banks thus become an instrument of a
more efficient use of available savings. An important outcome of this
process is a rise in the rate of savings and investment and there by in the
rate of growth.

1.2 Banking & its Evolution

The word 'Bank' is said to be derived from French word Bancus or
Banque, i.e., a bench. It is believed that the early bankers, the Jews in
Lombardy, transacted their business on benches in the market place.
Others think it is derived from German word "Back" meaning a Joint
stock fund.
The first modern bank was founded in Italy in Genoa in 1406; its name
was Banco di San Giorgio (Bank of St. George).
Many other financial activities were added over time. For example banks
are important players in financial markets and offer financial services
such as investment funds. In some countries such as Germany, banks are
the primary owners of industrial corporations while in other countries
such as the United States banks are prohibited from owning non-financial
companies. In Japan, banks are usually the nexus of cross share holding
entity known as zaibatsu .In France "Bancassurance" is highly present, as
most banks offer insurance services (and now real estate services) to their
clients.
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The concept of banking was first introduced in medieval Florence in
1397. A powerful merchant family named Medici established a network
of shops that allowed patrons to place money on account and withdraw
the money in another city that had a Medici representative. Many
powerful families and even the Church kept their money in Medici banks.
This allowed rich people to travel without the need to carry large sums of
money and risk of robbery while traveling. Banking continued to gain
popularity throughout Europe by 1700. Nearly every country in Europe
had some form of established banking. Modern banking has come a very
long way from those humble beginnings in Florence. Banking today
covers the entire spectrum of finance from simple savings to credit cards
and home loans. Typically, a bank generates profits from transaction fees
on financial services or the interest spread on resources it holds in trust
for clients while paying them interest on the asset. Banks today are
connected electronically so that banking transactions can be made
globally in asplit second.

1.3 Overview of Banking

The banking system in India is significantly different from that of other
Asian nations because of the country ‘s unique geographic, social, and
economic characteristics. India has a large population and land size, a
diverse culture, and extreme disparities in income, which are marked
among its regions. There are high levels of illiteracy among a large
percentage of its population but, at the same time, the country has a large
reservoir of managerial and technologically advanced talents. Between
about 30 and 35 percent of the population resides in metro and urban
cities and the rest is spread in several semi-urban and rural centers. The
country‘s economic policy framework combines socialistic and
capitalistic features with a heavy bias towards public sector investment.
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India has followed the path of growth-led exports rather than the “export-
led growth” of other Asian economies, with emphasis on self-reliance
through import substitution.
These features are reflected in the structure, size, and diversity of the
country‘s banking and financial sector. The banking system has had to
serve the goals of economic policies enunciated in successive five year
development plans, particularly concerning equitable income distribution,
balanced regional economic growth, and the reduction and elimination of
private sector monopolies in trade and industry. In order for the banking
industry to serve as an instrument of state policy, it was subjected to
various nationalization schemes in different phases (1955, 1969, and
1980). As a result, banking remained internationally isolated (few Indian
banks had presence abroad in international financial centers) because of
preoccupations with domestic priorities, especially massive branch
expansion and attracting more people to the system. Moreover, the sector
has been assigned the role of providing support to other economic sectors
such as agriculture, small-scale industries, export s, and banking
activities in the developed commercial centers (i.e., metro, urban, and a
limited number of semi-urban centers). The banking system‘s
international isolation was also due to strict branch licensing controls on
foreign banks already operating in the country as well as entry
restrictions facing new foreign banks. A criterion of reciprocity is
required for any Indian bank to open an office abroad. These features
have left the Indian banking sector with weaknesses and strengths. A big
challenge facing Indian banks is how, under the current ownership
structure, to attain operational efficiency suitable for modern financial
intermediation. On the other hand, it has been relatively easy for the
public sector banks to recapitalize, given the increases in nonperforming
assets (NPAs), as their Government dominated ownership structure has
reduced the conflicts of interest that private banks would face.
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1
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 Chapter-2
BANKING SYSTEM IN INDIA

2.1 Types of Banks

i)Scheduled Bank:
The banks in the Indian banking system are sub categorized as Scheduled
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Banks, Non-Schedule Banks, Private Banks and Public Banks. Scheduled
banks are those banks that are listed under Schedule II of the Reserve
Bank of India Act, 1934.
The bank's paid-up capital and raised funds must be at least Rs. 5 lakh to
qualify as a scheduled bank. These banks are liable for low interest loans
from the RBI.They also have membership in clearing houses.They also
have numerous obligations to fulfil such as maintaining an average daily
Cash Reserve Ratio with the central bank.

Types of Scheduled Banks in India:

The banks listed in Schedule II are further classified as –
Scheduled Commercial Public Sector Banks
SBI and its associates
Scheduled Commercial Private Sector Banks
Old Private Banks
New Private Sector Banks
Scheduled Foreign Banks in India

ii)Non-scheduled Banks:
 Non-scheduled banks by definition are those which are not listed in
the 2nd schedule of the RBI act, 1934.
 They don’t conform to all the criteria under clause 42, but dully
follow specific guidelines as laid down by RBI.
 Banks with a reserve capital of less than 5 lakh rupees qualify as
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 non-scheduled banks.
 Unlike scheduled banks, they are not entitled to borrow from the
RBI for normal banking purposes, except, in an emergency or
abnormal circumstances.
 Bangalore City Co-operative Bank Ltd. Bangalore, Baroda City Co-
op. Bank Limited are a few examples.

2.2 History of Indian Banking System

The first bank in India, called The General Bank of India was established
in the year 1786. The East India Company established The Bank of
Bengal/Calcutta (1809), Bank of Bombay (1840) and Bank of Madras
(1843). The next bank was Bank of Hindustan which was established in
1870. These three individual units (Bank of Calcutta, Bank of Bombay,
and Bank of Madras) were called as Presidency Banks. Allahabad Bank
which was established in 1865 was for the first time completely run by
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Indians. Punjab National Bank Ltd. was set up in1894 with head quarters
at Lahore. Between 1906 and 1913, Bank of India, Central Bank of India,
Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were
set up. In 1921, all presidency banks were amalgamated to form the
Imperial Bank of India which was run by European Shareholders. After
that the Reserve Bank of India was established in April 1935.
At the time of first phase the growth of banking sector was very slow.
Between 1913 and 1948 there were approximately 1100 small banks in
India. To streamline the functioning and activities of commercial banks,
the Government of India came up with the Banking Companies Act, 1949
which was later changed to Banking Regulation Act 1949 as per
amending Act of 1965 (Act No.23 of 1965). Reserve Bank of India was
vested with extensive powers for the supervision of banking in India as a
Central Banking Authority.
After independence, Government has taken most important steps in
regard of Indian Banking Sector reforms. In 1955, the Imperial Bank of
India was nationalized and was given the name "State Bank of India", to
act as the principal agent of RBI and to handle banking transactions all
over the country.
It was established under State Bank of India Act, 1955. Seven banks
forming subsidiary of State Bank of India was nationalized in 1960. On
19th July, 1969, major process of nationalization was carried out. At the
same time 14 major Indian commercial banks of the country were
nationalized. In 1980, another six banks were nationalized, and thus
raising the number of nationalized banks to20. Seven more banks were
nationalized with deposits over 200 Crores. Till the year 1980
approximately 80% of the banking segment in India was under
government‘s ownership. On the suggestions of Narsimhan Committee,
the Banking Regulation Act was amended in 1993 and thus the gates for
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the new private sector banks were opened.

2.3 GENERAL BANKING SCENARIO IN INDIA

The general banking scenario in India has become very dynamic now-a-
days. Before pre-liberalization era, the picture of Indian Banking was
completely different as the Government of India initiated measures to
play an active role int he economic life of the nation, and the Industrial
Policy Resolution adopted by the government in 1948 envisaged a mixed
economy. This resulted into greater involvement of the state in different
segments of the economy including banking and finance.
The Reserve Bank of India was nationalized on January 1, 1949 under the
terms of the Reserve Bank of India (Transfer to Public Ownership) Act,
1948. In 1949, the Banking Regulation Act was enacted which
empowered the Reserve Bank of India (RBI) "to regulate, control, and
inspect the banks in India." The Banking Regulation Act also provided
that no new bank or branch of an existing bank could be opened without
a license from the RBI, and no two banks could have common directors.
By the 1960s, the Indian banking industry had become an important tool
to facilitate the speed of development of the Indian economy. The
Government of India issued an ordinance and nationalized the 14 largest
commercial banks with effect from the midnight of July 19, 1969.A
second dose of nationalization of 6 more commercial banks followed in
1980.The stated reason for the nationalization was to give the
government more control of credit delivery. With the second dose of
nationalization, the Government of India controlled around 91% of the
banking business of India. Later on, in the year 1993, the government
merged New Bank of India with Punjab National Bank. It was the only
merger between nationalized banks and resulted in the reduction of the
number of nationalised banks from 20 to 19. After this, until the 1990s,
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the nationalised banks grew at a pace of around 4%, closer to the average
growth rate of the Indian economy. In the early 1990s, the then
Narasimha Rao government embarked on a policy of liberalization,
licensing a small number of private banks. The next stage for the Indian
banking has been set up with the proposed relaxation in the norms for
Foreign Direct Investment, where all Foreign Investors in banks may be
given voting rights which could exceed the present cap of 10%, at present
it has gone up to 74%with some restrictions.
The new policy shook the Banking sector in India completely. Bankers,
till this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%;
Go home at 4) of functioning. The new wave ushered in a modern
outlook and tech-savvy methods of working for traditional banks. All this
led to the retail boom in India. People not just demanded more from their
banks but also received more.

I.Current Scenario
The industry is currently in a transition phase. On the one hand, the

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PSBs, which are the mainstay of the Indian Banking system, are in the
process of shedding their flab in terms of excessive manpower, excessive
non Performing Assets (Npas) and excessive governmental equity, while
on the other hand the private sector banks are consolidating themselves
through mergers and acquisitions. PSBs, which currently account for
more than 78 percent of total banking industry assets are saddled with
NPAs (a mind-boggling Rs 830 billion in 2000), falling revenues from
traditional sources, lack of modern technology and a massive workforce
while the new private sector banks are forging ahead and rewriting the
traditional banking business model by way of their sheer innovation and
service. The PSBs are of course currently working out challenging
strategies even as 20 percent of their massive employee strength has
dwindled in the wake of the successful Voluntary Retirement Schemes
(VRS) schemes.
The private players however cannot match the PSB‟s great reach, great
size and access to low cost deposits. Therefore one of the means for them
to combat the PSBs has been through the merger and acquisition (M& A)
route. Over the last two years, the industry has witnessed several such
instances. For instance, Hdfc Bank‘ s merger with Times Bank, Icici
Bank‘s acquisition of ITC Classic, Anagram Finance and Bank of
Madura. Centurion Bank, IndusInd Bank, Bank of Punjab, Vysya Bank
are said to be on the lookout. The UTI bank- Global Trust Bank merger
however opened a pandora‘s box and brought about the realization that
all was not well in the functioning of many of the private sector banks.
Private sector Banks have pioneered internet banking, phone banking,
anywhere banking, mobile banking, debit cards, Automatic Teller
Machines (ATMs) and combined various other services and integrated
them into the mainstream banking arena, while the PSBs are still
grappling with disgruntled employees in the aftermath of successful VRS
schemes. Also, following India’s commitment to the W To agreement in
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respect of the services sector, foreign banks, including both new and the
existing ones, have been permitted to open up to 12 branches a year with
effect from 1998-99 as against the earlier stipulation of 8 branches.

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 Chapter-3

Reserve Bank of India And Financial Institutions

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RBI is the banker to banks whether commercial, cooperative, or rural.
There lationship is established once the name of a bank is included in the
Second Schedule to the Reserve Bank of India Act, 1934. Such bank,
called a scheduled bank, is entitled to facilities of refinance from RBI,
subject to fulfillment of the following conditions laid down in Section 42
(6) of the Act, as follows:
• It must have paid-up capital and reserves of an aggregate value of not
less than an amount specified from time to time; and
• It must satisfy RBI that its affairs are not being conducted in a manner
detrimental to the interests of its depositors. The classification of
commercial banks into scheduled and nonscheduled categories that was
introduced at the time of establishment of RBI in 1935 has been extended
during the last two or three decades to include state cooperative banks,
primary urban cooperative banks, and RRBs. RBI is authorized to
exclude the name of any bank from the Second Schedule if the bank,
having been given suitable opportunity to increase the value of paid-up
capital and improve deficiencies, goes into liquidation or ceases to carry
on banking activities.
A system of local area banks announced by the Government in power
until 1997has not yet taken root. RBI has given in principle clearance to
five applicants. Specialized development financial institutions (DFIs)
were established to resolve market failures in developing economies and
shortage of long-term investments. The first DFI to be established was
the Industrial Finance Corporation of India (IFCI) in 1948, and was
followed by SFCs at state level setup under a special statute. In 1955,
Industrial Credit and Investment Corporation of India (ICICI) were set up
in the private sector with foreign equity participation. This was followed
in 1964 by Industrial Development Bank of India (IDBI) set up as a
subsidiary of RBI. The same year saw the founding of the first mutual
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fund in the country, the Unit Trust of India (UTI).
A wide variety of financial institutions (FIs) has been established.
Examples include the National Bank for Agriculture and Rural
Development (NABARD),Export Import Bank of India (Exim Bank),
National Housing Bank (NHB), and Small Industries Development Bank
of India (SIDBI), which serve as apex banks in their specified areas of
responsibility and concern. The three institutions that dominate the term-
lending market in providing financial assistance to the corporate sector
are IDBI, IFCI, and ICICI. The Government owns insurance companies,
including Life Insurance Corporation of India (LIC)and General
Insurance Corporation (GIC). Subsidiaries of GIC also provide
substantial equity and loan assistance to the industrial sector, while UTI,
though a mutual fund conducts similar operations. RBI also set up in
April 1988 the Discount and Finance House of India Ltd (DFHI) in
partnership with SBI and other banks to deal with money market
instruments and to provide liquidity to money markets by creating a
secondary market for each instrument. Majors hares of DFHI are held by
SBI. Liberalization of economic policy since 1991has highlighted the
urgent need to improve infrastructure in order to provide services of
international standards. Infrastructure is woefully inadequate for the
efficient handling of the foreign trade sector, power generation,
communication, etc. For meeting specialized financing needs, the
Infrastructure Development Finance Company Ltd. (IDFC) was set up in
1997. To nurture growth of private capital flows, IDFC will seek to
unbundle and mitigate the risks that investors face in infrastructure and to
create an efficient financial structure at institutional and project levels.
IDFC will work on commercial orientation, innovations in financial
products, rationalizing the legal and regular framework, creation of
along-term debt market, and best global practices on governance and risk
management in infrastructure projects.
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3.1 What is the Role of the Reserve bank of India (RBI)

i)Monetary functions of RBI:

The RBI holds the authority to issue and manage the currency of India.It
formulates and implements monetary policies to maintain price stability,
manage inflation, and control money supply.
By setting the repo rate and reverse repo rate, the RBI influences
borrowing costs and, in turn, the money supply in the economy.

ii) 2. Regulator and Supervisor:

The function of RBI as the apex regulator and supervisor of the Indian
financial system.
It oversees banks, non-banking financial companies (NBFCs), and other
financial institutions, ensuring their soundness, stability, and adherence to
prudential norms. This role bolsters consumer confidence and safeguards
the integrity of the financial system.

iii) Banker to the Government and Banks:

The RBI serves as the banker to both the Central and State
governments.It manages government funds, facilitates transactions, and
manages public debt.
Additionally, it provides banking services to other banks, acting as the
lender of last resort during financial crises.

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iv) Controller of Credit:
The RBI influences the credit flow in the economy to achieve desired
economic outcomes.
It formulates credit policies and regulates the lending practices of banks,
controlling the availability and cost of credit for various sectors.

v) Foreign Exchange Management:

As the custodian of India's foreign exchange reserves, the RBI manages
the exchange rate of the Indian rupee, facilitating international trade and
maintaining external stability.
It devises policies to promote and regulate foreign exchange transactions.

vi) Developmental Role:

The functions and the role of RBI plays a pivotal role in promoting
financial inclusion and development.
It supports initiatives that enhance banking services accessibility,
strengthen payment systems, and foster innovations in the financial
sector.

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3.2 Role of RBI in Financial Markets
In the complex network of financial markets, the role and functions of
Reserve Bank of India serve as a guardian, ensuring that transactions are
transparent, fair, and efficient. It plays a crucial role in shaping monetary
policy, maintaining liquidity, regulating markets, managing foreign
exchange, and promoting development. The multifaceted contributions of
the RBI are instrumental in steering the Indian economy toward stability
and growth. The role of RBI in the financial markets continues to light
the way forward, safeguarding the nation's economic prosperity. Foreign
Exchange Reserves (FOREX) play a crucial role in a country's economic
stability and global trade. The Reserve Bank of India (RBI) holds the
responsibility of managing these reserves efficiently. In this blog, we will
explore the key components of RBI's Foreign Exchange Reserve
Management Policy.

1. Diversification Strategies:
‍Allocation across major foreign currencies.
Incorporation of liquid and safe assets.
‍Consideration of investment risks and potential returns.

2. Risk Management:
Identification and mitigation of potential risks.
Emphasis on maintaining value and liquidity.
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‍Regular stress testing to assess resilience against adverse scenarios.

3. Sovereign and Supranational Securities:

‍Government investment and supra-national debt.
‍Focus on the stability and security of issuer countries

4. Gold Reserves:
‍Maintenance of a certain percentage of reserves in gold.
‍Hedge against currency and geopolitical risks.

5. Foreign Investment Instruments:

‍Strategic investments in high-quality foreign instruments.
‍Balancing risk and return while ensuring liquidity.

6. Market Trends and Developments:

‍Monitoring global economic and financial trends.
‍Adapting the policy to changing market dynamics.

7. Foreign Exchange Rate Management:

‍Intervention in the foreign exchange market to manage volatility.
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‍Balancing domestic economic goals with exchange rate stability.

8. Liquidity Management:
‍Ensuring quick access to funds when needed.
‍Optimal balance between liquidity and returns.

9. Transparency and Disclosure:

‍Regular reporting on reserve composition and performance.
‍Enhanced communication to build trust with stakeholders.

10. Collaboration and Cooperation:

‍Coordination with international organizations and central banks.
‍Participation in global initiatives for reserve management.

11. Long-Term Objectives:

‍Preservation of purchasing power over time.
‍Supporting economic resilience during external shocks.

‍12. Domestic and External Considerations:

‍Alignment with domestic monetary and fiscal policies.
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‍Integration of reserve policy with external trade dynamics.

3.3 Supervisory Role performed by the RBI

The Reserve Bank of India (RBI) also has a few supervisory functions in
overseeing and monitoring. These responsibilities include:

1.Licensing and Regulation of Banks

‍2. Capital Adequacy and Prudential Norms

‍3. Risk Assessment and Management

‍4. Supervision of Non-Banking Financial Companies (NBFCs)

‍5. Consumer Protection and Market Conduct

‍6. Information Dissemination and Transparency

‍7. Resolution of Stressed Assets

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‍8. Supervision of Payment and Settlement Systems

3.4 Role of RBI in the Indian economy

The role and functions of the RBI are fundamental to the stability and
growth of the Indian economy.
By managing money supply, interest rates, and inflation, the RBI creates
an environment conducive to investment, economic growth, and job
creation. Its supervision and regulation of financial institutions ensure the
safety and soundness of the financial system, fostering investor
confidence and stability.
The role of RBI in the Indian Economy is nothing short of instrumental.
As India continues its journey on the path of development, the RBI
remains a steadfast guardian of economic well-being, and soundness of
the financial system, fostering investor confidence and stability toward a
more prosperous future.
In conclusion, the Reserve Bank of India stands as a beacon of financial
wisdom and resilience. The RBI constitution and management functions
reflect a commitment to upholding economic stability, while its
multifaceted functions underscore its vital role in the nation's growth
story.
As the Indian economy continues to evolve, the RBI remains an
unwavering custodian, navigating the dynamic seas of finance with
prudence and purpose.

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3.5 INDIAN BUSINESS AND ECONOMIC ENVIRONMENT
DURING 2011-12
Fiscal 2012 was a challenging year for the global economy. Prolongedun
certainty around the resolution of the Euro zone sovereign debt crisis,
rating down grades of sovereigns and slow recovery of the US economy
increased risks to global growth. The Indian economy saw moderation in
economic activity during fiscal 2012, following domestic macroeconomic
conditions of high interest rates and slowdown in investments. India’s
gross domestic product (GDP) grew by 6.9% during the first nine months
of fiscal 2012, compared to a growth of 8.1% in the corresponding period
of fiscal 2011. During this period, the industrial sector grew by 3.3%
compared to 7.0% in the corresponding period of the previous year. The
45 services sector grew by 8.8%, similar to the growth in the previous
year, while the agriculture sector grew by 3.2%compared to 6.8%.
Investments, as measured by gross fixed capital formation, declined by
0.2% during the first nine months of fiscal 2012 compared to a growth of
8.9% in the corresponding period of fiscal 2011. Private consumption
growth also moderated to 5.1% during the first nine months of fiscal
2012compared to 8.5% in the corresponding period of fiscal 2011. The
Index of Industrial Production (IIP) recorded a growth of 3.5% year-on
year (y-o-y) during the first eleven months of fiscal 2012 compared to
8.1% increase in the corresponding period of fiscal 2011. During this
period, production in the mining sector declined by 2.1%, while the
manufacturing sector recorded a growth of 3.7% and electricity sector of
8.7%, as compared to growth of 5.8%,8.7% and 5.3% respectively in the
first eleven months of fiscal 2011. The Central Statistical Organization
has estimated GDP growth for fiscal 2012 at6.9%, compared to 8.4% in
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fiscal 2011 Inflation, measured by the Wholesale Price Index (WPI),
remained above 9.0% levels between April 2011 - November 2011 but
moderated from thereon to end the year at 6.9% in March2012. Average
inflation for fiscal 2012 was 8.8% as compared to 9.5% in fiscal2011.
The decrease was largely driven by falling inflation in food articles,
which declined from 15.8% in fiscal 2011 to 7.4% in fiscal 2012.
Manufactured products inflation initially went up to above 8.0% levels
till November 2011, but moderated to 4.9% by March 2012. Core
inflation (defined as manufactured products excluding food products)
reduced from 8.5% in March 2011 to 4.7% in March 2012. Reserve Bank
of India (RBI) calibrated its policy stance in line with macroeconomic
conditions. During fiscal 2012, the repo rate was increased by 175 basis
points from 6.75% to 8.50%, with the last increase of 25 basis points
effective from October 25, 2011. Based on the moderation in economic
growth and the inflation trajectory, RBI in its mid-quarter monetary
policy review in December 2011 paused further tightening of policy
rates. In the third quarter monetary policy review announced in January
2012, RBI reduced the cash reserve ratio (CRR) by 50 basis points from
6.0% to 5.50%. CRR was further reduced by 75 basis points in March
2012 to 4.75%. In its annual policy review for fiscal 2013 announced in
April 2012, RBI reduced the repo rate by50 basis points to 8.00%. During
fiscal 2012, in an attempt to improve monetary transmission in the
system, RBI established the repo rate as the single independent policy
rate with the reverse repo pegged at a fixed 100 basis points below the
repo rate. Also, a new Marginal Standing Facility was introduced under
which banks could borrow overnight up to one per cent of their net
demand and time liabilities, at 100 basis points above the repo rate.
Liquidity in the system continued to remain in deficit through fiscal
2012. Compared to an average borrowing by banks under the liquidity
adjustment facility (LAF)window of RBI of Rs. 470.82 billion in fiscal
2011. Average borrowing increased to Rs. 798.78 billion in fiscal 2012.
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The liquidity deficit crossed Rs.1.00 trillion from November 2011. The
average daily borrowing touched a peak of Rs. 1.96 trillion in end-March
2012. In view of the tight liquidity conditions, from the reduction in
CRR, RBI also injected liquidity through open market operations
aggregating around Rs. 1.30 trillion between November 2011 and March
2012. The yields on the benchmark 10 year government securities
increased by about 58 basis points to 8.57% at March 30, 2012 from
7.99% at March 31, 2011. In response to tight liquidity conditions and a
rising interest rate environment, scheduled commercial banks increased
their deposit and lending rates particularly in the first half of fiscal 2012.
In April 2012, systemic liquidity conditions have improved with the
deficit reducing to around Rs.900.00 billion at April 23, 2012. Several
banks have reduced their lending and deposit rates following the
monetary policy announcement.
Non-food credit growth moderated during the year, from 21.3% at March
25,2011 to 16.8% at March 23, 2012, before picking up towards the end
of the year. Non-food credit growth at March 30, 2012 was 19.3%. Based
on sector-wise data available till February 2012, growth in credit to
industry was 19.1%and to the services sector was 15.2% on a year-on-
year basis. Credit to the infrastructure sector moderated significantly
recording a growth of 18.7% year-on-year at February 24, 2012
compared to 39.7% at February 25, 2011 mainly due to a slowdown in
credit to the power and telecommunication sectors. Retail loan growth
also slowed down to 11.4% year-on-year at February 24, 2012compared
to 16.2% at February 25, 2011. Similarly, deposit growth moderated
during the year from 15.9% at March 25, 2011 to 13.4% at March 23,
2012, driven mainly by the decline in demand deposit growth from a
reduction of0.6% at March 25, 2011 to a reduction of 2.9% at March 23,
2012. Deposit growth picked up at the yearend, with year-on-year growth
in demand deposits at 15.3% and term deposits at 17.7% at March 30,
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2012.
The Union Budget for fiscal 2013 has projected the government’s fiscal
deficit to come down from an estimated 5.9% of GDP in fiscal 2012 to
5.1% in fiscal 2013. RBI has projected India’s GDP to grow by 7.3% in
fiscal 2013, with credit growth estimated at 17.0% and deposit growth at
16.0%. RBI has projected inflation to be at 6.5% in March 2013. Equity
markets remained volatile during fiscal 2012 due to global and domestic
events. The Euro zone sovereign debt crisis and sovereign rating
downgrades by rating agencies along with the global economic slowdown
impacted investor sentiment, particularly in the second and third quarter
of fiscal 2012. On an overall basis, the benchmark equity index, the BSE
Sensex, declined by 10.4% from 19,445 at March 31,2011 to 17,404 at
March 31, 2012. Foreign institutional investment flows into India during
fiscal 2012 were significantly lower compared to fiscal 2011, with net
inflows of around USD 2.74 billion during the first nine months of
fiscal2012 compared to USD 29.46 billion in the corresponding period of
fiscal 2011.In addition, a steeper slowdown in exports compared to
imports during the year, contributed to a deficit of USD 7.09 billion in
India’s balance of payments during the first nine months of fiscal 2012 as
compared to a surplus of USD11.02 billion during the corresponding
period of fiscal 2011. The rupee depreciated by 14.6% against the US
dollar from Rs. 44.65 per US dollar at March 31, 2011 to Rs. 51.16 per
US dollar at March 31, 2012. First year retail premium underwritten in
the life insurance sector decreased by 4.8% (on weighted received
premium basis) to Rs. 479.41 billion in fiscal 2012 from Rs.503.68
billion in fiscal 2011. The average assets under management of mutual
funds decreased by 5.1% to Rs. 6,647.92 billion in March 2012 from
Rs.7,005.38 billion in March 2011. Gross premium of the non-life
insurance sector (excluding specialized insurance institutions) grew by
23.0% to Rs. 547.62 billion in fiscal 2012 from Rs. 445.34 billion in
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fiscal 2011.

3.6 Banking Developments

The moderation in GDP growth following monetary tightening by RBI

affected business growth of banks, which is reflected in slowdown in
their deposit and credit growth. While deposit growth of All Scheduled
Commercial Banks (ASCB) decelerated to 13.4% in FY‗12 from 15.9%
FY‗11 despite increase in interest rates, growth in ASCB credit was
lower at 17.0% in FY‗12 than 21.5%in FY‗11 reflecting slower growth
in the economy. To control inflation, RBI raised the repo rate five times
during FY‗12 from 7.25% to 8.50%. Reflecting monetary transmission,
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interest rates on bank deposits and credit also rose. Deposit rate of major
banks for more than one year maturity rose from 7.75-9.50% in FY‗11 to
8.50-9.25% in FY‗12, and base rate of major banks rose from 8.25-
9.50% to 10.0- 10.75% in the same period. Due to deceleration ingrowth
impinging on corporate profitability and move to system-driven
identification of NPAs, non-performing assets of banks rose during the
year 49.

3.7 Opportunities and Threats

The Government is increasing investment in agriculture and rural

development, expanding financial inclusion and pushing for investment
in manufacturing and infrastructure, which will translate into growth
opportunities for several sectors such as steel, cement, aluminum, etc. To
boost growth, RBI is likely to cut rates further during FY 13, though the
extent of rate cuts will be contingent on the inflation trajectory. All this
will provide an opportunity for banks to increase fund and non-fund
business in a wide range of areas. Banks will be required to cut interest
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on credit in tandem with cut in key policy rate by RBI. However, due to
high cost funds mobilized over the last year and large NPAs and
restructured assets, banks may find it difficult to pass on the entire
reduction in repo rate to customers. Net Interest Margin (NIM) of banks
could come under pressure as it may be difficult for banks to cut interest
rates on deposits due to sluggish deposit growth reflecting the declining
trend in savings in financial assets as households favour physical assets
like gold and real estate.

3.8 Risks and Concerns

The main risks to the outlook are slowing global growth as the Euro zone
sovereign debt crisis continues. High international oil and commodity
prices could also dampen growth. As a result of the vast pools of liquidity
injected by central banks of advanced countries to stimulate growth and
prevent bank deleveraging, India will need to guard against volatile
capital flows and build-up of asset bubbles. The situation could be
exacerbated by the return of risk aversion and deleveraging by banks in
developed economies. Monsoons, inflation including food inflation and
suppressed inflation on account of fuel prices, widening current account
deficit, and fiscal slippage leading to higher fiscal deficit are major risk
factors. The fiscal deficit is estimated to be 5.1% in FY‗13 but slower
revenue generation through tax collections as well as disinvestment
proceeds, and rise in expenditure can lead to higher net market
borrowings by the Government than the targeted Rs.4.79 lakh crore.
Rising oil prices, as also slowing export growth due to weakness in
global demand could lead to widening of the current account deficit in
FY‗13.
Inflation could rise on the back of supply constraints from a slowdown in
growth. Liquidity is likely to remain a concern and banks may need to
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strive for higher resources mobilization besides tapping all sources of
refinance, to avoid liquidity pressure. Overall, the biggest concern is that
despite strengths such as a large domestic market, high domestic savings
rate and vast scope for investment, India’s growth remains below its
potential.

3.9 GROWTH DRIVERS OF THE BANKING SECTOR

High growth of Indian Economy: The growth of the banking industry is

closely linked with the growth of the overall economy. India is one of the
fastest growing economies in the world and is set to remain on that path
for many years to come. This will be backed by the stellar growth in
infrastructure, industry, services and agriculture. This is expected to boost
the corporate credit growth in the economy and provide opportunities to
banks to lend to fulfill these requirements in the future.

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Rising per capita income: The rising per capita income will drive the
growth of retail credit. Indians have a conservative outlook towards credit
except for housing and other necessities. However, with an increase in
disposable income and increased exposure to a range of products,
consumers have shown a higher willingness to take credit, particularly,
young customers. A study of the customer profiles of different types of
banks reveals that foreign and private banks share of younger customers is
over 60% whereas public banks have only32% customers under the age of
40. Private Banks also have a much higher share of the more profitable
mass affluent segment.

New channel-Mobile banking is expected to become the second largest

channel for banking after ATMs:
New channels used to offer banking services will drive the growth of
banking industry exponentially in the future by increasing productivity
and acquiring new customers. During the last decade, banking through
ATMs and internet has shown a tremendous growth, which is still in the
growth phase. After ATMs, mobile banking is expected to give another
push to this industry growth in a big way; with the help of new 3G and
smart phone technology (mobile usage has grown tremendously over the
years).This can be looked at as branchless banking and so will also reduce
costs as there is no need for physical infrastructure and human resources.
This will help in acquiring new customers, mainly who live in rural areas
(though this will take time due to technology and infrastructure issues).

Financial Inclusion Program: Currently, in India, 41% of the adult

population Doesn’t have bank accounts, which indicates a large untapped
market for banking players. Under the Financial Inclusion Program, RBI
is trying to tap this untapped market and the growth potential in rural
markets by volume growth for banks. Financial inclusion is the delivery of
banking services at an affordable cost to the vast sections of
disadvantaged and low income groups. The RBI has also taken many
initiatives such as Financial Literacy Program, promoting effective use of
development communication and using Information and Communication
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Technology (ICT) to spread general banking concepts to people in the
underbanked areas. All these initiatives of promoting rural banking are
taken with the help of mobile banking, self help groups, microfinance
institutions, etc. Financial Inclusion, on the one side, helps corporate in
fulfilling their social responsibilities and on the other side it is fueling
growth in other industries and so as a whole economy.

3.10 CONCERNS OF BANKING SECTORS

More stringent capital requirements to achieve as per Basel III:

Recently, the RBI released draft guidelines for implementing Basel III. As
per the proposal, banks will have to augment the minimum core capital
after astringent deduction. The two new requirements capital conservative
buffer (an extra buffer of 2.5% to reduce risk) and a counter cyclical
buffer (an extra capital buffer if possible during good times) have also
been introduced for banks. As the name indicates that the capital
conservative buffer can be dipped during stressed period to meet the
minimum regulatory requirement on core capital. In this scenario, the
bank would not be supposed to use its earnings to make discretionary
payouts such as dividends, shares buyback, etc. The countercyclical
buffer, achieved through a pro-cyclical build up of the buffer in good
times, is expected to protect the banking industry from system-wide risks
arising out of excessive aggregate credit growth.
Under current Basel Norm II, Indian banks follow more stringent capital
adequacy requirements than their international counterparts. For Indian
Banks, the minimum common equity requirement is 3.6%, minimum tier
I capital requirement is 6% and minimum total capital adequacy
requirement is 9% as against 2%, 4% and 8% respectively recommended
in the Basel II Norm. Due to this the capital adequacy position of Indian
banks is at comfortable level. So, going ahead, they should not face much
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problem in meeting the new norms requirements. But as we saw earlier,
private sector banks and foreign banks have considerable high capital
adequacy ratio, hence are not expected to face any problem. But, public
sector banks are lagging behind. So, the Government will have to infuse
capital in public banks to meet Basel III requirements.With the higher
minimum core Tier I capital requirement of 7-9.5% and overall Tier I
capital of 8.5-11%, Banks ROE is expected to come down.

Increasing non-performing and restructured assets:

Due to a slowdown in economic activity in past couple of years and
aggressive lending by banks many loans have turned non-performing.
Restructuring of assets means loans whose duration has been increased or
the interest rate has been decreased. This happens due to inability of the
loan taking company/individual to pay off the debt. Both of these have
impacted the profitability of banks as they are required to have a higher
provisioning amount which directly eats into the profitability. The key
challenge going forward for banks is to increase loans and effectively
manage NPAs while maintaining profitability.

Intensifying competition:
Due to homogenous kind of services offered by banks, large number of
players in the banking industry and other players such as NBFCs,
competition is already high. Recently, the RBI released the new Banking
License Guidelines for NBFCs. So, the number of players in the Indian
banking industry is going to increase in the coming years. This will
intensify the competition in the industry, which will decrease the market
share of existing banks.

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Managing Human Resources and Development:
Banks have to incur a substantial employee training cost as the attrition
rate is very high. Hence, banks find it difficult manage the human
resources and development initiatives.

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 Chapter – 4

MAJOR DEVELOPMENTS
The Monetary Authority of Singapore (MAS) has provided qualified full
banking (QFB) privileges to ICICI Bank for its branch operations in
Singapore. Currently, only SBI had QFB privileges in country. The
Indian operations of Standard Chartered reported a profit of above US$ 1
billion for the first time. The bank posted a profit before tax (PAT) of
US$ 1.06 billion in the calendar year 2009, as compared to US$ 891
million in 2008. Punjab National Bank(PNB) plans to expand its
international operations by foraying into Indonesia and South Africa. The
bank is also planning to increase its share in the international business
operations to 7 per cent in the next three years. The State Bank of India
(SBI) has posted a net profit of US$ 1.56 billion for the nine months
ended December 2009, up 14.43 per cent from US$ 175.4 million posted
in the nine months ended December 2008.

4.1 BANKING SECTOR IN LIBERALIZED PERIOD

The year 1991 marked a decisive changing point in India's economic
policy since Independence in 1947.Following the 1991 balance of
payments crisis, structural reforms were initiated that fundamentally
changed the prevailing economic policy in which the state was supposed
to take the "commanding heights" of the economy. After decades of far
reaching government involvement in the business world, known as the
"mixed economy" approach, the private sector started to play a more
prominent role. The enacted reforms not only affected the real sector of
the economy, but the banking sector as well. Characteristics of banking in
India before 1991 were a significant degree of state ownership and far
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reaching regulations concerning among others the allocation of credit and
the setting of interest rates. The blue print for banking sector reforms was
the 1991 report of the Narasimham Committee. Reform steps taken since
then include a deregulation of interest rates, an easing of directed credit
rules under the priority sector lending arrangements, a reduction of
statutory pre-emptions, and a lowering of entry barriers for both domestic
and foreign players.
The regulations in India are commonly characterized as "financial
repression". The financial liberalization literature assumes that the
removal of repressionist policies will allow the banking sector to better
perform its functions of mobilizing savings and allocating capital what
ultimately results in higher growth rates .If India wants to achieve its
ambitious growth targets of 7-8% per year as lined out in the Common
Minimum Programme of the current government, a successful
management of the systemic changes in the banking sector is a necessary
precondition. While the transition process in the banking sector has
certainly not yet come to an end, sufficient time has passed for an interim
review. The objective of this paper therefore is to evaluate the progress
made in liberalizing the banking sector so far and to test if the reforms
have allowed the banking sector to better perform its functions.
The paper proceeds as follows: section 2 gives a brief overview over the
role of the banking sector in an economy and possible coordination
mechanisms. A discussion of different repressive policies and their effect
on the functioning of the banking sector follows in section 3. Section 4
gives a short historical overview over developments in the Indian
banking sector and over the reforms since1991.

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4.2 ROLE AND MANAGEMENT OF THE BANKING SECTOR

A banking sector performs three primary functions in an economy: the

operation of the payment system, the mobilization of savings and the
allocation of savings to investment projects. By allocating capital to the
highest value use of the positive influence on the overall economy, and is
thus of broad macro economic importance since the general importance
of a banking sector for an economy is widely accepted, the questions
arise under which coordination mechanism state or market it best
performs its functions, and, if necessary, how to manage the transition to
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this coordination mechanism Currently, there are opposing views
concerning the most preferable coordination mechanism. According to
the development and political view of state involvement in banking, a
government is through either direct ownership of banks or restrictions on
the operations of banks better suited than market forces alone to ensure
that the banking sector performs its functions. The argument is essentially
that the government can ensure a better economic outcome by for
example channelling savings to strategic projects that would otherwise
not receive funding or by creating a branch infrastructure in rural areas
that would not be build by profit maximizing private banks. The active
involvement of government thus ensures a better functioning of the
banking sector, which in turn has a growth enhancing effect. The
proponents of financial liberalization take an opposite stance. In their
view, repressive policies such as artificially low real interest rates,
directed credit programs and excessive statutory pre-emptions that are
imposed on banks have negative effects on both the volume and the
productivity of investments . Removing these repressionist policies and
giving more importance to market forces will, in the view of the
proponents of financial liberalization, increase financial development and
eventually lead to higher economic growth. A majority of empirical
studies support the conclusion of the financial liberalization hypothesis.
The policy recommendations arising from the se studies are evident:
abolishment of repressionist policies and privatization of state-owned
banks.

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4.3 DEVELOPMENT OF THE INDIAN BANKING SECTOR

Development from Independence until 1991:

At the time of Independence in 1947, the banking system in India was
fairly well developed with over 600 commercial banks operating in the
country. However, soon after Independence, the view that the banks from
the colonial heritage were biased in favour of working-capital loans for
trade and large firms and against extending credit to small-scale
enterprises, agriculture and commoners, gained prominence. To ensure
better coverage of the banking needs of larger parts of the economy and
the rural constituencies, the Government of India (GOI) created the State
Bank of India (SBI) in 1955. Despite the progress in the 1950s and
1960s, it was felt that the creation of the SBI was not far reaching enough
since the banking needs of small scale industries and the agricultural
sector were still not covered sufficiently. This was partly due to the still
existing close ties commercial and industry houses maintained with the
established commercial banks, which gave them an advantage in
obtaining credit. Additionally, there was a perception that banks should
play a more prominent role in India's development strategy by mobilizing
resources for sectors that were seen as crucial for economic expansion.
As a consequence, in1967 the policy of social control over banks was
announced. Its aim was to cause changes in the management and
distribution of credit by commercial banks. Following the Nationalization
Act of 1969, the 14 largest public banks were nationalized which raised
the Public Sector Banks' (PSB) share of deposits from31% to 86%. The
two main objectives of the nationalizations were rapid branch expansion
and the channelling of credit in line with the priorities of the five-year
plans. To achieve these goals, the newly nationalized banks received
quantitative targets for the expansion of their branch network and for the
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percentage of credit they had to extend to certain sectors and groups in
the economy, the so-called priority sectors, which initially stood at
33.3%. Six more banks were nationalized in 1980, which raised the
public sector's share of deposits to 92%. The second wave of
nationalizations occurred because control over the banking system
became increasingly more important as a means to ensure priority sector
lending, reach the poor through a widening branch network and to fund
rising public deficits. In addition to the nationalization of banks, the
priority sector lending targets were raised to 40. However, the policies
that were supposed to promote a more equal distribution of funds, also
led to inefficiencies in the Indian banking system. To alleviate the
negative effects, a first wave of liberalization started in the second half of
the 1980s. The main policy changes were the introduction of Treasury
Bills, the creation of money markets, and a partial deregulation of interest
rates. Besides the establishment of priority sector credits and the
nationalization of banks, the government took further control over banks'
funds by raising the statutory liquidity ratio (SLR) and the cash reserve
ratio (CRR). From a level of 2% for the CRR and 25% for the SLR in
1960, both witnessed a steep increase until 1991 to 15% and 38.5%
respectively. In summary, India's banking system was at least until an
integral part of the government's spending policies. Through the directed
credit rules and the statutory pre-emptions it was a captive source of
funds for the fiscal deficit and key industries. Through the CRR and the
SLR more than 50% of savings had either to be deposited with the RBI or
used to buy government securities. Of the remaining savings, 40% had to
be directed to priority sectors that were defined by the government.
Besides these restrictions on the use of funds, the government had also
control over the price of the funds, i.e. the interest rates on savings and
loans. This was about to change at the beginning of the 1990s when a
balance-of payments crisis was a trigger for far-reaching reforms
Developments after 1991.
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Like the overall economy, the Indian banking sector had severe structural
problems by the end of the 1980s. Joshi and Little characterize the
banking sector by 1991 as unprofitable, inefficient, and financially
unsound. By international standards, Indian banks were even despite a
rapid growth of deposits extremely unprofitable. In the second half of the
1980s, the average return on assets was about 0.15%. The return on
equity was considerably higher at 9.5%, but merely reflected the low
capitalization of banks. While in India capital and reserves stood at about
1.5% of assets, other Asian countries reached about 4-6%. These figures
do not take the differences in income recognition and loss provisioning
standards into account, which would further deteriorate the relative
performance of Indian banks. The 1991 report of the Narasimham
Committee served as the basis for the initial banking sector reforms. In
the following years, reforms covered the areas of interest rate
deregulation, directed credit rules, statutory pre-emptions and entry
deregulation for both domestic and foreign banks. The objective of
bankings ector reforms was in line with the overall goals of the 1991
economic reforms of opening the economy, giving a greater role to
markets in setting prices and allocating resources, and increasing the role
of the private sector.

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4.4 The most important reforms follows:

Statutory pre-emptions:

The degree of financial repression in the Indian banking sector was

significantly reduced with the lowering of the CRR and SLR, which were
regarded as one of the main causes of the low profitability and high
interest rate spreads in the banking system. During the 1960s and 1970s
the CRR was around 5%, but until1991 it increased to its maximum legal
limit of 15%. From its peak in 1991, it has declined gradually to a low of
4.5% in June 2003. In October 2004 it was slightly increased to 5% to
counter inflationary pressures, but the RBI remains committed to
decrease the CRR to its statutory minimum of 3%. The SLR has seen a
similar development. The peak rate of the SLR stood at 38.5% in
February 1992, just short of the upper legal limit of 40%. Since then, it
has been gradually lowered to the statutory minimum of 25% in October
1997. The reduction of the CRR and SLR resulted in increased flexibility
for banks in determining both the volume and terms of lending.

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Priority sector lending:

Besides the high level of statutory pre-emptions, the priority sector

advances were identified as one of the major reasons for the below
average profitability of Indian banks. The Narasimham Committee
therefore recommended reduction from 40% to 10%. However, this
recommendation has not been implemented and the targets of 40% of net
bank credit for domestic banks and 32% for foreign banks have remained
the same. While the nominal targets have remained unchanged, the
effective burden of priority sector advances has been reduced by
expanding the definition of priority sector lending to include for example
information technology companies.

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Interest rate liberalization:
Prior to the reforms, interest rates were a tool of cross-subsidization
between different sectors of the economy. To achieve this objective, the
interest rate structure had grown increasingly complex with both lending
and deposit rates set by the RBI. The deregulation of interest rates was a
major component of the banking sector reforms that aimed at promoting
financial savings and growth of the organized financial system. The
lending rate for loans in excess of Rs200,000 that account for over 90%
of total advances was abolished in October 1994. Banks were at the same
time required to announce a prime lending rate (PLR) which according to
RBI guidelines had to take the cost of funds and transaction costs into
account. For the remaining advances up to Rs200,000 interest rates can
be set freely as long as they do not exceed the PLR. On the deposit side,
there has been a complete liberalization for the rates of all term deposits,
which account for 70% of total deposits. The deposit rate liberalization
started in 1992 by first setting an overall maximum rate for term deposits.
From October 1995, interest rates for term deposits with a maturity of
two years were liberalized. The minimum maturity was subsequently
lowered from two years to 15 days in 1998. The term deposit rates were
fully liberalized in 1997. As of 2004, the RBI is only setting the savings
and the non-resident Indian deposit rate. For all other deposits above 15
days, banks are free to set their own interest rates.

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Entry barriers:

Before the start of the 1991 reforms, there was little effective competition
in the Indian banking system for at least two reasons. First, the detailed
prescriptions of the RBI concerning for example the setting of interest
rates left the banks with limited degrees of freedom to differentiate
themselves in the market place. Second, India had strict entry restrictions
for new banks, which effectively shielded the incumbents from
competition. Through the lowering of entry barriers, competition has
significantly increased since the beginning of the1990s. Seven new
private banks entered the market between 1994 and 2000. In addition,
over 20 foreign banks started operations in India since 1994. By March
2004, the new private sector banks and the foreign banks had a combined
share of almost 20% of total assets.
Deregulating entry requirements and setting up new bank operations has
benefited the Indian banking system from improved technology,
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specialized skills, better risk management practices and greater portfolio
diversification.

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Prudential norms:
The report of the Narasimham Committee was the basis for the
strengthening of prudential norms and the supervisory framework.
Starting with the guideline son income recognition, asset classification,
provisioning and capital adequacy the RBI issued in 1992/93, there have
been continuous efforts to enhance the transparency and accountability of
the banking sector. The improvements of the prudential and supervisory
framework were accompanied by a paradigm shift from micro-regulation
of the banking sector to a strategy of macro-management. The Basle
Accord capital standards were adopted in April 1992. The 8% capital
adequacy ratio had to be met by foreign banks operating in India by the
end of March 1993, Indian banks with a foreign presence had to reach the
8% by the end of March 1994 while purely domestically operating banks
had until the end of March 1996 to implement the requirement.

Significant changes were also made concerning non-performing assets

(NPA) since banks can no longer treat the putative 'income' from them as
income. Additionally, the rules guiding their recognition were tightened.
Even though these changes mark a significant improvement, the
accounting norms for recognizing NPAs are less stringent than in
developed countries where a loan is considered nonperforming after one
quarter of outstanding interest payments compared to two quarters in
India.

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Public Sector Banks:
At the end of the 1980s, operational and allocative inefficiencies caused
by the distorted market mechanism led to a deterioration of Public Sector
Banks' profitability. Enhancing the profitability of PSBs became
necessary to ensure the stability of the financial system. The restructuring
measures for PSBs were three fold and included recapitalization, debt
recovery and partial privatization. Despite the suggestion of the
Narasimham Committee to rationalize PSBs, the Government of India
decided against liquidation, which would have involved significant losses
accruing to either the government or depositors. It opted instead to
maintain and improve operations to allow banks to create a good starting
basis before a possible privatization. Due to directed lending practices
and poor risk management skills, India's banks had accrued a significant
level of NPAs. Prior to any privatization, the balance sheets of PSBs had
to be cleaned up through capital injections. In the fiscal years 1991/92
and 1992/93 alone, the GOI provided almost Rs40 billion to clean up the
balance sheets of PSBs. Between 1993 and 1999 another Rs120 billion
were injected in the nationalized banks.
In total, the recapitalization amounted to 2% of GDP. In 1993, the SBI
Act of 1955 was amended to promote partial private shareholding. The
SBI became the first PSB to raise equity in the capital markets. After the
1994amendment of the Banking Regulation Act, PSBs were allowed to
offer up to49% of their equity to the public. This lead to the further
partial privatization of eleven PSBs. Despite those partial privatizations,
the government is committed to keep their public character by
maintaining strong administrative control such as the ability to appoint
key personnel and influence corporate strategy. After an overview of the
developments in the Indian banking sector over the last years, the next
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section tries to measure the changing degree of finance until 1991 to15%
and 38.5% respectively.
4.5 CHALLENGES FACED BY INDIAN BANKING INDUSTRY
Developing countries like India, still has a huge number of people who
do not have access to banking services due to scattered and fragmented
locations. But if we talk about those people who are availing banking
services, their expectations are raising as the level of services are
increasing due to the emergence of Information Technology and
competition. Since, foreign banks are playing in Indian market, the
number of services offered has increased and banks have laid emphasis
on meeting the customer expectations. Now, the existing situation has
created various challenges and opportunity for Indian Commercial Banks.
In order to encounter the general scenario of banking industry we need to
understand the challenges and opportunities lying with banking industry
of India.

Rural Market:
Banking in India is generally fairly mature in terms of supply, product
range and reach, even though reach in rural India still remain’s a challenge
for the private sector and foreign banks. In terms of quality of assets and
capital adequacy, Indian banks are considered to have clean, strong and
transparent balance sheets relative to other banks in comparable
economies in its region. Consequently, we have seen some examples of
inorganic growth strategy adopted by some nationalized and private sector
banks to face upcoming challenges in banking industry of India.
For example recently, ICICI Bank Ltd. merged the Bank of Rajasthan Ltd.
in order to increase its reach in rural market and market share
significantly.
State Bank of India (SBI), the largest public sector bank in India has also
adopted the same strategy to retain its position. It is in the process of
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acquiring its associates. Recently, SBI has merged State Bank of Indore in
2010.

Management of Risks:
The growing competition increases the competitiveness among banks.
But, existing global banking scenario is seriously posing threats for Indian
banking industry. We have already witnessed the bankruptey of some
foreign banks

Growth of Banking:
Banks' ownership structure does not seem to matter as much as increased
competition in TFP growth. Foreign banks appear to have acted as
technological innovators when competition increased, which added to the
competitive pressure in the banking market. Finally, our results also
indicate an increase in risk-taking behaviour, along with the whole
deregulation process. It was found that small and local banks face
difficulty in bearing the impact of global economy therefore, they need
support and it is one of the reasons for merger. Some private banks used
mergers as a strategic tool for expanding their horizons. There is huge
potential in rural markets of India, which is not yet explored by the major
banks. Therefore ICICI Bank Ltd. has used mergers as their expansion
strategy in rural market. They are successful in making their presence in
rural India. It strengthens their network across geographical boundary,
improves customer base and market share.

Market Discipline and Transparency:

Transparency and disclosure norms as part of internationally accepted
corporate governance practices are assuming greater importance in the
emerging environment. Banks are expected to be more responsive and
accountable to the investors. Banks have to disclose in their balance sheets
a plethora of information on the maturity profiles of assets and liabilities,
lending to sensitive sectors, movements in NPAs, capital, provisions,
shareholdings of the government, value of investment in India and abroad,
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operating and profitability indicators, the total investments made in the
equity share, units of mutual funds, bonds, debentures, aggregate advance
against shares and so on.

Human Resource Management:

Significant correlations were found between work climate, human

resource practices, and business performance. The results showed that the
correlations between climate and performance cannot be explained by
their common dependence on HRM factors, and that the data are
consistent with a mediation model in which the effects of HRM practices
on business performance are partially mediated by work climate. The
relationship between human resource management and establishment
performance of employees on the manufacturing sector. The HRM
environment could vary across branches. Site visits provided specific
examples of managerial practices that affected branch performance. An
analysis of responses to the bank's employee attitude survey that controls
for unobserved branch and manager characteristics shows a positive
relationship between branch performance and employees’ satisfaction
with the quality of performance evaluation, feedback, and recognition at
the branch-the -incentives dimension of a feedback, and recognition at the
branch-the -incentives dimension of a high-performance work system. In
some fixed effects specifications, satisfaction with the quality of
communications at the branch was important.

Global Banking:

It is practically and fundamentally impossible for any nation to exclude

itself from world economy. Therefore, for sustainable development, one
has to adopt integration process in the form of liberalization and
globalization as India spread the red carpet for foreign firms in 1991.
The impact of globalization becomes challenges for the domestic
enterprises as they are bound to compete with global players. If we look at
the Indian Banking Industry, then we find that there are 36 foreign banks
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operating in India, which becomes a major challenge for Nationalized and
private sector banks. These foreign banks are large in size, technically
advanced and having presence in global market, which gives more and
better options and services to Indian traders.
Financial Inclusion:

Financial inclusion has become a necessity in today's business

environment. Whatever is produced by business houses, that has to be
under the check from various perspectives like environmental concerns,
corporate governance, social and ethical issues. Apart from it to bridge the
gap between rich and poor, the poor people of the country should be given
proper attention to improve their economic condition.

Employees' Retention:

The banking industry has transformed rapidly in the last ten years, shifting
from transactional and customer service-oriented to an increasingly
aggressive environment, where competition for revenue is on top priority.
Long-time banking employees are becoming disenchanted with the
industry and are often resistant to perform up to new expectations. The
diminishing employee morale results in decreased revenue. Due to the
intrinsically close ties between staff and clients, losing those employees
completely can mean the loss of valuable customer relationships. The
retail banking industry is concerned about employee retention from all
levels: from tellers to executives to customer service representatives
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because competition is always moving in to hire them away. The
competition to retain key employees is intense. Top-level executives and
HR departments spend large amounts of time, effort, and money trying to
figure out how to keep their people from leaving.
4.6 Non-Banking Financial Company(NBFC):

under the Companies Act, 1956 engaged in the business of loans and
advances, acquisition of shares/stocks/bonds/debentures/securities issued
by Government or local authority or other marketable securities of a like
nature, leasing, hire-purchase, insurance business, chit business but does
not include any institution whose principal business is that of agriculture
activity, industrial activity, purchase or sale of any goods (other than
securities) or providing any services and sale/purchase/construction of
immovable property. A non-banking institution which is a company and
has principal business of receiving deposits under any scheme or
arrangement in one lump sum or in installments by way of contributions
or in any other manner, is also a non-banking financial company
(Residuary non-banking company).

In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial

company can commence or carry on business of a non-banking financial
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institution without (a) obtaining a certificate of registration from the Bank
and without having a Net Owned Funds of ₹ 25 lakhs (₹ Two crore since
April 1999). However, in terms of the powers given to the Bank, to
obviate dual regulation, certain categories of NBFCs which are regulated
by other regulators are exempted from the requirement of registration with
RBI viz. Venture Capital Fund/Merchant Banking companies/Stock
broking companies registered with SEBI, Insurance Company holding a
valid Certificate of Registration issued by IRDA, Nidhi companies as
notified under Section 620A of the Companies Act, 1956, Chit companies
as defined in clause (b) of Section 2 of the Chit Funds Act, 1982,Housing
Finance Companies regulated by National Housing Bank, Stock Exchange
or a Mutual Benefit company.

4.7 Organisation and Function of RBI:

~ Organisation:-

The RBI formulates and implements the government’s monetary policy,

issues bank notes and coins, manages the country’s international payments
and its foreign-exchange market, acts as an investment bank for the central
and state governments, and maintains the accounts of, and extends credit
to, commercial banks.

RBI is the central bank of India and in this article, we will be discussing
the Structure and Functions of RBI. The topic is important for various
banking exams like IBPS PO, IBPS Clerk, NABARD, RBI Grade B, SBI,
SBI PO, SBI CBO, JAIIB, CAIIB but also important for other
Government recruitment exams like SSC, UPSC, etc.

~ Functions of RBI:-

i)Monetary Authority

The Reserve Bank of India being the central bank of the country is the
monetary authority of India and the sole authority vested with the power
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to issue currency notes, regulate the supply of currency and credit in the
economy to secure monetary and price stability.

Regulate & Supervise Financial Stability and Financial inclusion

It is also the responsibility of RBI to regulate & supervise the banking
sector with an eye on securing financial stability and financial inclusion.

ii) Currency Management:-

Currency Management is the process of managing the life cycle of the

notes, which includes:

Assessing the printing requirement of various denominations of notes,

Placing indents with the note printing presses,
Supplying and distributing adequate quantity of currency throughout the
country.

Ensuring the quality of banknotes in circulation by continuous supply of

clean notes and timely withdrawal of soiled notes.

Section 23 of the RBI Act, 1934, had mandated that the function of
issuance of banknotes (above 1 Rupee) is to be conducted by the RBI
through a separate department called the Issue Department.

4.8 Regulate and Supervise the financial system:-

Financial system in India is carried out by different regulatory authorities.

The Reserve Bank regulates and supervises the major part of the financial
system. The supervisory role of the Reserve Bank involves commercial
banks, Urban Co-operative Banks (UCBs), certain Financial Institutions
(FIs) and Non-Banking Financial Companies (NBFCs). Some of the FIs,
in turn, regulate and/or supervise other institutions in the financial sector.

In addition to these, the Reserve Bank of India also represents India at the
International Monetary Fund (IMF), promotes the growth of the economy,
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act as a lender of last resort to commercial banks, strengthen and support
small local banks and encourage banks to open branches in rural areas,
publish economic data, etc.

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 Chapter-5

FINDINGS, SUGGESTIONS AND CONCLUSIONS

5.1 Findings

Majority of bankers are of the opinion that business environment is highly

competitive. Nearly half of the bankers say the competition is faced from
public, private, cooperative and foreign banks. Majority of bankers find
very difficult to survive, grow, stabilize and excel in banking business.

For doing banking business effectively the strategies adopted are use of
advance technology, changes in working process and improving bank
performance. Out of resources used in banking business the manpower is
most important and money is ranked second. Nearly three-fourth of banks
agreed that the major advantages of higher performance to banks are
quality and quantity improvement, high productivity, employees'
satisfaction and higher profitability.

More than half of bankers said that management of banks is highly

interested to manage performance of employees consistently. More than
half of bankers said that the major functions performed by performance
management are setting goals and performance standards, communication,
coaching feedback, performance appraisal and development planning for
future.

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5.2 Suggestions

The present business environment for banking is highly volatile and

uncertain.

It is highly competitive and every bank is finding difficult to service grow,

stabilize and excel in banking business.

Further, for better performance management must keep watch on the

emerging trends in business environment.

The proper and timely strategies are to be adopted to improve efficiency

of the whole organization Competition is faced from public, private,
foreign and cooperative banks.

They have adopted the strategy for effective workings are use of advance
technology and changes in working procedure.

No doubt performance has been improved but manpower is not

maintained and utilized properly.

For improvement in human resources, special focus should be given on

selection, training, motivate career opportunities or employees etc.

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5.3 Conclusion

We are in the era of globalization and the business environment is very

turbulent. It is changing drastically. In present environment nothing is
permanent except changes. Changes are likely to take place but with
different pace at different time. External environmental factors like social,
cultural, economic, legal, government policies, technology and
competition are uncontrollable.

Due to these, it has become very difficult to carry out the business
activities effectively and efficiently. It is an uphill task to stabilize, grow
and excel in the business performance. In this situation, the need for
higher level of knowledge and skills are needed. Every organization
whether big or small, is using manpower, machine, money and materials.
To carry out its tasks these are needed and without these the tasks cannot
be completed.

In present scenario under liberalization, privatization and globalization the

companies are facing stiff competition. It has become very difficult to
survive, grow, stabilize and excel in the business. The companies
performing better and before others are taking the lead in business. To do
so the skilled and motivated employees are strongly needed. They can
give more output per person.

Their performance can be measured with the help of labour productivity

concept. The labour efficiency can be measured with the help of
productivity concept.

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