UNIT 4
MONEY AND BANKING
Money market is the short-term financial market of economy. Here, money is traded between individuals or groups like institutions, banks, government, etc. These individuals or groups are either cash surplus or cash scarce. Trading is done in accordance with ‘discount rate’, which is determined by the market and guided by supply and demand of cash in day-to-day trading. The ‘repo rate’, which is announced by the RBI from time to time, works as guiding rate for the ‘discount rate’.
Following can be considered to be features of money market:
1. Money market has no geographical constraints as that of stock market. Even though there can be centers of money market like Mumbai but still Financial institutions dealing these assets are spread over a large area.
2. The money market is for short term funds
3. Money market operates in both organized and unorganized sector.
4. No brokers are required for transaction in money market.
5. Indian money market faces seasonal variations, it has busy season and slack season.
6. Government and semi government securities play a dominant role in the Indian money market.
7. Indian money market is isolated from foreign money market; there is hardly any movement of funds between the two markets.
8. The Indian money market has large number of financial institutions such as non-banking financial securities, cooperative banks, and export import banks.
Key Takeaways:
- Money market is the short-term financial market of economy. Here, money is traded between individuals or groups like institutions, banks, government, etc.
- Trading is done in accordance with ‘discount rate’, which is determined by the market and guided by supply and demand of cash in day-to-day trading.
Reserve bank of India was set up in 1935 as a private with two extra functions i.e. regulation and control of banks in India. After nationalization in 1949 it became central banking body in India and as a result did not remain a ‘bank’ in technical terms.
Monetary policy is the most dynamic and sensitive function of the RBI. It is related to monetary matters mainly concerned with regulating the size and cost of money in the economic system. Monetary Policy Committee announce the policy 6 times in a financial year.
Generally, the tone of the monetary policy is set by the first one announced at the beginning of every financial year
RBI uses following tools to set the desired monetary policy:
- CRR: The cash reserve ratio (CRR) is the ratio of the total deposits of the bank in India kept in RBI in form of cash. In the recent past it has been mostly around 4%. RBI increases the CRR to reduce the liquidity and reduces the CRR to increase the liquidity.
- SLR: Statutory liquidity ratio is the minimum proportion of bank’s deposits which a bank has to maintain with itself in cash and non cash form. It is used to control the bank’s credibility for credit expansion.
- Bank rate: The interest charged by RBI on its long-term lending to bank is called Bank rate. The bank rate has direct impact on long term lending of commercial lending institutions operating in Indian financial system.
- Repo Rate (Rate of purchase): The interest rates the RBI charges on its short-term lending is called Repo rate. Reduction in repo rate encourages the lending institutions to lend more and increase in repo rate discourages the lending. It is used to control the inflation
- Reverse repo rate: It is rate of interest commercial banks get when they deposit their money in RBI. It is also used to influence lending and control inflation.
- Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow an additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
Problems faced by India’s Monetary Policy:
- Limited role in controlling inflation: The monetary policy has not completely succeeded in achieving growth with stability. In the words of former governor of RBI, Mr. I G Patel, ’ the role of monetary policy in combating inflation is strictly limited and that monetary policy can be effective only if it is a part of an overall framework of policy which includes not only fiscal and foreign exchange policy but also what is described as an income policy’.
- Unfavorable banking habits: In India majority of people prefer to use cash instead of cheques and online transfers, this reduces the cash availability with the banks and hence reduces their lending capacity. However a steady change in transaction behavior was noticed in post demonitisation world and also due to restrictions of pandemic people had to use online transactions.
- Underdevelopment of money market: Coverage of monetary policy is limited by underdeveloped money market. The money market comprises of the parts, the organized money market and unorganized money market. The money policy works only in organized money market. It fails to achieve the desired results in unorganized money market.
- Black money: Black money rises as giver and taker both decide to keep transaction a secret, as a result supply and demand does not remain same as desired by the monetary policy.
- Conflict of objectives: To achieve the objective of economic development the monetary policy is to be expansionary but contrary to it to achieve the objective of price stability a curb on inflation can be realised by contracting the money supply. The monetary policy generally fails to achieve a proper coordination between these two objectives.
Key Takeaways:
- Monetary policy is the most dynamic and sensitive function of the RBI. It is related to monetary matters mainly concerned with regulating the size and cost of money in the economic system.
- RBI uses tools like CRR, SLR, Repo Rate, Bank Rate, etc.
The financial institutions which accept deposits from public and then lend to consumers for consumption or investment are called commercial banks.
The story of progress of commercial banking in India goes hand in hand with nationalization process. After RBI was nationalized in 1949 and central banking was established, the government considered nationalization of private banks to increase the reach of banking sector, as at that time the reach of the then private commercial banks was very narrow. The nationalization was also required to direct the banking from profit oriented to welfare oriented. Moreover the planned development of economy requires certain degree of government control on capital in the economy, for this nationalization of banks was required.
After successful experimentation in the partial nationalization, goverment in 1969 completely nationalized 20 private banks. Until the recent merger, the number of nationalized banks had continuously grown.
However, after the reforms of 1991, goverment allowed private banks in the country.UTI was the first such bank, since then many private banks have started operating in the country. Thus after economic reforms of 1991, we can see the reversal of policies governing the banks in country.
On Oct 2 1975, the government took a very important step to provide banking services at the doorstep of rural masses by establishing Regional rural banks (RRBs). The aim was to provide credit to the weaker sections of the society at the concessional rate so as to replace the private money lending and to use the rural savings for productive activities in rural areas.
Since Independence Indian commercial banking sector has a lot of changes and it certainly has played a huge role in development of the country.
In economy, the long-term financial market is called Capital market. This market raises the required long-term credit i.e., for the period of 365 days or more. This market garnered strength due to industrialization. In initial period banks were the only segment in this market but gradually insurance industry, mutual funds and stock market were also added. Managing organized development and sound regulatory framework has always been difficult but sound and vibrant capital market makes it a much manageable task.
After independence, India approached the industrialization intensively to achieve rapid growth and development. For industrialization, there is a huge requirement of capital. To fulfill this requirement goverment decided to depend on internal and external borrowings, also the financial institutions were set up. The industrial financing done by these institutions was called ‘project financing’.
The frequent requirement of project financing made government go for many financial institutions, these are classified into four categories viz. All India Financial Institutions (AIFIs), Specialized Financial Institutions (SFIs), Investment Institutions (IIs) and State Level Finance Institutions (SLFIs).
- AIFIs: Few examples of AIFIs are IFCI, IDBI, and SIDBI. AIFIs have played very important role in the development process but due to more or less fixed rate of interest in comparison with banks, the AIFIs seem to become irrelevant. AIFIs have seen sharp decline in lending in recent years.
- SFIs: Two FIs were set up by goverment in the late 1980s to finance risk and innovation in industrial expansion. These are called SFI.
- IIs: Three investment institutions were set up i.e. LIC, UTI and GIC. However the roles played by these institutions have changed with time, there are no longer known as investment institutions.
- SLFIs: With the involvement of state in industrialization, the central goverment allowed the states to set up their own financial institutions. Hence two kinds of financial institutions were set up viz. State finance corporation and State industrial development corporation.
Key Takeaways:
- In economy, the long-term financial market is called Capital market. This market raises the required long-term credit i.e., for the period of 365 days or more.
- The frequent requirement of project financing made government go for many financial institutions, these are classified into four categories viz. All India Financial Institutions (AIFIs), Specialized Financial Institutions (SFIs), Investment Institutions (IIs) and State Level Finance Institutions (SLFIs).
The security and exchange board in India (SEBI) has the responsibility of regulation of the securities and commodity market in India.
The Preamble of the SEBI states its basic functions as "...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected there with or incidental there to".
SEBI has the responsibility to meet requirements of following three categories i.e.
Issuers: SEBI provides a marketplace in which the issuers can increase their finance.
Investors : SEBI ensures safety and supply of precise and accurate information.
Intermediaries: SEBI enables a competitive professional market for intermediaries
SEBI also has quasi legislative and quasi judicial functions. So it can draft regulations, conduct inquiries, pass rulings and impose penalties.
It can also approve bylaws of securities exchanges, it can inspect the book of accounts and call for periodical returns, it can cause companies to list their shares in one or more securities exchanges and it registers brokers and sub brokers.
Key Takeaways:
- The security and exchange board in India (SEBI) has the responsibility of regulation of the securities and commodity market in India.
- SEBI also has quasi legislative and quasi-judicial functions. So, it can draft regulations, conduct inquiries, pass rulings and impose penalties.
References
- Indian Banking by S. Chand
- Banking System in India by S. M. Javed Akhtar
