Indian banking policy response by the rbi to the global financial crisis
Introduction:
Globalization could be defined as “Growing interdependence of countries world-wide through the increasing volume and variety of cross-border transactions in goods and services and of international capital flows, and also through the more rapid and widespread diffusion of technology” (Johnson and Turner, 2003 p 10). It is argued that the negative integration of breaking down trade and protective barriers and consequences of the speed and size of the capital flows in international financial markets which led to the distressing costs of the developed countries in the form of subprime crisis in which lies the reason for global financial crisis. (Herbert Oberhänsli/Oscar Vera, 2003).
As a result of the global financial crisis central banks across the world have responded in terms of fiscal and monetary levels. The Reserve Bank of India has also responded with certain fiscal and monetary measures. This report speaks about effects of global financial crisis over the Indian Banking sector and RBI’s policy response towards it.
Impact over Indian banking sector:
As a result of the financial crisis of the US and globalization most of the European, UK and Asian countries were adversely affected. The affect on Indian Economy was negligible but still had some impact which is very pre matured to be quantified at this point. Indian bank’s having incredibly low revelation to the subprime mortgage assets markets of the developed countries has not experienced many losses when compared to other western countries banks. This is because of the major role played by the nationalized banks and their controls over domestic finance. Also the strictly adopted rules of Reserve Bank of India could protect India from getting insulated from the traits of the western counteracts. It is predicted that the future exposure of Indian banks to the investment bankers of the USA could show its adverse impacts over Indian banking sector. (A. Prasad and C Panduranga Reddy, 2009).
Indian financial markets like money market, equity market, forex market and credit market came under pressure and found their overseas financing drying up due to the reversal of capital flows. As a result of which the economic growth decelerated from 9.5%, 9.7 % and 9 % in 2005-06, 2006-07, 2007-08 respectively to 6.7 % during the year 2008 -09. (UNESCAP, 2009)
Also since the import content is not that high the multiplier effect for economic activity of exports over the Indian GDP is high. Hence a slump in exports would directly help the fall of GDP growth rate in India. “It is more important to focus policy attention on removing some of the many remaining structural bottlenecks on raising the potential GDP growth rate.”(Rajeev Kumar, director and executive ICRIER, 2009).
RBI’s policy response:
During the consequences of the chaos caused due to bankruptcy RBI has taken certain measures to ensure systematic operation of financial markets and financial stability which includes extension of liquidity support to banks. The financial crisis in developed countries led to lack of trust among the major players which almost froze the un-collateralized interbank money markets. Central banks in larger economies have taken steps to increase the short term liquidity requirement and also lost collateral requirement to provide the short term liquidity in some cases. “The global financial turmoil has had knock-on effects on our financial markets; this has reinforced the importance of focusing on preserving financial stability,” India’s central bank (Financial times, 2008)
Though India was not much affected by the turmoil it was under pressure and RBI with its consistent monetary policies effectively managed the monetary conditions and domestic liquidity. This was enabled with the appropriate use of multiple instruments like repo and reverse repo; statutory liquidity ratio (SLR), cash reserve ratio (CRR), open market operations, including the Liquidity Adjustment Facility (LAF) and market stabilization scheme (MSS), special market operations, and sector specific liquidity facilities.
Further, due to our forex market operations the money market liquidity was impacted which in turn reflected the developing capital flows. The huge capital flows and their absorption by RBI in 2007 and its previous years led to excess liquidity, which were engrossed through operations like MSS, LAF and CRR. The MSS and LAF being able to bear a major part of the load, some inflections in SLR and CRR were resorted (Dr. Rakesh Mohan, 2008).
Various policy initiatives imposed by RBI have provided sufficient rupee liquidity to ensure ease of dollar liquidity and maintain a market environment responsible for sustained credit flows to productive sectors. Since September 2008 RBI has taken certain key policy initiatives which are listed below:
“Policy Rates:
- Under the liquidity adjustment facility (LAF) the policy repo rate was condensed by 400 basis points of 9.0 % to 4.75 %.
- Under the LAF the policy reverse repo rate was reduced by 250 basis points from 6.0 % to 3.25 %.
Rupee Liquidity:
- The cash reserve ratio (CRR) was reduced from 9.0% of net demand and time liabilities (NDTL) of banks to 5.0 % account for a deduction of 400 basis points.
- The export credit refinance limit for commercial banks was improved to from 15.0 % of outstanding export credit to 50.0 %.
- The statutory liquidity ratio (SLR) was reduced to 24.0 % of NTDL from 25.0 %.
- A special 14-day term repo facility was organized for commercial banks up to an NTDL of 1.5 %.
- Special refinance facilities were instituted for financial institutions (NHB, SIDBI and Exim Bank).
- A special refinance facility was instituted for scheduled commercial banks (excluding RRBs) up to 1.0 % of each bank’s NDTL as on October 24, 2008.
Forex Liquidity:
- The Reserve Bank sold foreign exchange (US dollars) and made available a forex swap facility to banks.
- The interest rate ceilings on nonresident Indian (NRI) deposits were raised.
- The all-in-cost ceiling for the external commercial borrowings (ECBs) was raised. The all-in-cost ceiling for ECBs through the approval route has been dispensed with up to June 30, 2009.
- The systemically important non-deposit taking non-banking financial companies (NBFCs-ND-SI) were permitted to raise short-term foreign currency borrowings.
Regulatory Forbearance:
- The risk-weights and provisioning requirements were relaxed and restructuring of stressed assets was initiated”. (UNESCAP, 2009)
India’s Finance Minister Mr. Pranab Mukherjee during the budget speech of 2010 says, That the Indian banking system has to grow in both size and sophistication to meet the needs of a modern economy and also the geographic coverage of the banks have to be extended to improve access to banking services. He further adds, by announcing that additional banking licenses have been given to private sector players by RBI. (Financial times 2010).
It is evident that, despite the tremendous chaos in global financial markets India could cope well because of its strong growth, careful practices and embraced reserves. The key component of the current monetary policy stance lies in active liquidity management. RBI has always and will continue with its active demand management policy of liquidity through proper use of the CRR requisites and open market operations including LAF and the MSS using policy instruments with flexibility of being situational.
Impact of policy Response:
The results of the actions taken by RBI since September 2008 were shown in the increase of actual potential liquidity of over Rs.4, 22,000 crores. The permanent reduction in the SLR by 1.0% of NDTL has made liquid funds of the order of Rs.40, 000 crores available for the purpose of credit expansion. (See appendix 1)
The overnight money markets which floated above the repo rate between September-October 2008 have lessened and have come close to lower bound of the LAF since November 2008. Also the liquidity problem which faced by mutual funds has been relieved to a large extent. Most of the commercial banks have lowered standard prime lending rates. Under the contemporary finance/liquidity facilities initiated by RBI, the total utilization has been low and the overall liquidity remains at ease. Their availability has provided flexibility to banks/FI’s to fall back when needed. (See appendix 2).
Considering the measures taken by RBI since mid September 2008 Indian financial markets maintained consistency to operate in a systematic manner showing improvement in the annual budget report of 2010. “The effectiveness of these policy measures became evident with fast paced recovery. The economy stabilized in the first quarter of 2009-10 itself, when it clocked a GDP growth of 6.1 per cent, as against 5.8 per cent in the fourth quarter of the preceding year. It registered a strong rebound in the second quarter, when the growth rate rose to 7.9 per cent. With the Advance Estimates placing the likely growth for 2009-10 at 7.2 per cent, we are indeed vindicated in our policy stand. The final figure may well turn out to be higher when the third and fourth quarter GDP estimates for 2009-10 become available.” (Pranab Mukherjee, 2010)
However, as criticized by the industrialists in India, the packages announced are not adequate enough to boost up the economic growth as the monetary policies and fiscal incentives further delay the process. Also due to the slow liberation system they do not guarantee the outcome within a given time and do not ensure change in market confidence. They have requested the government to review these proposals for relief and potential bailout. (Pro. K. P Kannan, ILO, 2009). On the whole, Though India has taken policy measures to recover from the global financial crisis, it is satisfactory enough for the Industrialists who feel it does not have a proper employment target and the policies are more focused on liquidity augmentation instead of providing fiscal incentives to export leaning sectors.
Conclusion:
India has fled from the infectivity of the subprime turmoil to a great extent for various reasons. The growth process of India is majorly reliant on foreign savings and has remained 1.5% in the topical years. The credit derivatives market in India is still in the initial stages and the originate-to-distribute model in India is no comparable to the ones existing in the developed market as there are certain restrictions on investments by locals in investing in such products abroad and also the guidelines do not permit to quick profits. On whole financial stability in India has been maintained through firmness of policies which avoid surfeit risk and financial markets being very impulsive and unstable.
The future of India’s banking system lies in using the Leadership and experience to innovate the management of banking. Now, India’s potential lies in reinventing banking system making use of the developments in IT services over the next decade. This would enable India to become one of the world’s most competitive banks over the next 10 years. India’s strategy of, whether to export the talent in banking structures or to keep hold of the leadership within the country would be the most captivating phase of India’s financial services development over the next 10 years.