Banking in India

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Structure of the organised banking sector in India. Number of banks are in brackets.

Banking in India originated in the last decades of the 18th century. The first banks were
The General Bank of India which started in 1786, and the Bank of Hindustan, both of
which are now defunct. The oldest bank in existence in India is the State Bank of India,
which originated in the Bank of Calcutta in June 1806, which almost immediately
became the Bank of Bengal. This was one of the three presidency banks, the other two
being the Bank of Bombay and the Bank of Madras, all three of which were established
under charters from the British East India Company. For many years the Presidency
banks acted as quasi-central banks, as did their successors. The three banks merged in
1921 to form the Imperial Bank of India, which, upon India's independence, became the
State Bank of India.

Contents
[hide]

• 1 History
• 2 Post-Independence
• 3 Nationalisation
• 4 Liberalisation
• 5 Further reading
• 6 References

• 7 External links

[edit] History
Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as
a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in
1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock
Bank: A company that issues stock and requires shareholders to be held liable for the
company's debt) It was not the first though. That honor belongs to the Bank of Upper
India, which was established in 1863, and which survived until 1913, when it failed, with
some of its assets and liabilities being transferred to the Alliance Bank of Simla.

When the American Civil War stopped the supply of cotton to Lancashire from the
Confederate States, promoters opened banks to finance trading in Indian cotton. With
large exposure to speculative ventures, most of the banks opened in India during that
period failed. The depositors lost money and lost interest in keeping deposits with banks.
Subsequently, banking in India remained the exclusive domain of Europeans for next
several decades until the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire
d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in
1862; branches in Madras and Puducherry, then a French colony, followed. HSBC
established itself in Bengal in 1869. Calcutta was the most active trading port in India,
mainly due to the trade of the British Empire, and so became a banking center.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in
1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established
in Lahore in 1895, which has survived to the present and is now one of the largest banks
in India.

Around the turn of the 20th Century, the Indian economy was passing through a relative
period of stability. Around five decades had elapsed since the Indian Mutiny, and the
social, industrial and other infrastructure had improved. Indians had established small
banks, most of which served particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange
banks and a number of Indian joint stock banks. All these banks operated in different
segments of the economy. The exchange banks, mostly owned by Europeans,
concentrated on financing foreign trade. Indian joint stock banks were generally under
capitalized and lacked the experience and maturity to compete with the presidency and
exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it
seems we are behind the times. We are like some old fashioned sailing ship, divided by
solid wooden bulkheads into separate and cumbersome compartments."

The period between 1906 and 1911, saw the establishment of banks inspired by the
Swadeshi movement. The Swadeshi movement inspired local businessmen and political
figures to found banks of and for the Indian community. A number of banks established
then have survived to the present such as Bank of India, Corporation Bank, Indian Bank,
Bank of Baroda, Canara Bank and Central Bank of India.

The fervour of Swadeshi movement lead to establishing of many private banks in

Dakshina Kannada and Udupi district which were unified earlier and known by the name
South Canara ( South Kanara ) district. Four nationalised banks started in this district
and also a leading private sector bank. Hence undivided Dakshina Kannada district is
known as "Cradle of Indian Banking".

During the First World War (1914-1918) through the end of the Second World War
(1939-1945), and two years thereafter until the independence of India were challenging
for Indian banking. The years of the First World War were turbulent, and it took its toll
with banks simply collapsing despite the Indian economy gaining indirect boost due to
war-related economic activities. At least 94 banks in India failed between 1913 and 1918
as indicated in the following table:

Number of banks Authorised capital Paid-up Capital

Years
that failed (Rs. Lakhs) (Rs. Lakhs)
1913 12 274 35
1914 42 710 109
1915 11 56 5
1916 13 231 4
1917 9 76 25
1918 7 209 1

[edit] Post-Independence
The partition of India in 1947 adversely impacted the economies of Punjab and West
Bengal, paralyzing banking activities for months. India's independence marked the end of
a regime of the Laissez-faire for the Indian banking. The Government of India initiated
measures to play an active role in the 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 major steps to regulate banking included:

• The Reserve Bank of India, India's central banking authority, was nationalized on
January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public
Ownership) Act, 1948 (RBI, 2005b).[Reference www.rbi.org.in]
• 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.

[edit] Nationalisation

Banks Nationalisation in India: Newspaper Clipping, Times of India, July, 20, 1969
Despite the provisions, control and regulations of Reserve Bank of India, banks in India
except the State Bank of India or SBI, continued to be owned and operated by private
persons. By the 1960s, the Indian banking industry had become an important tool to
facilitate the development of the Indian economy. At the same time, it had emerged as a
large employer, and a debate had ensued about the nationalization of the banking
industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the
Government of India in the annual conference of the All India Congress Meeting in a
paper entitled "Stray thoughts on Bank Nationalisation." The meeting received the paper
with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an
ordinance and nationalised the 14 largest commercial banks with effect from the midnight
of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the step as a
"masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the
Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking)
Bill, and it received the presidential approval on 9 August 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, the nationalised banks grew at a pace of around 4%,
closer to the average growth rate of the Indian economy.

[edit] Liberalisation
In the early 1990s, the then Narsimha Rao government embarked on a policy of
liberalization, licensing a small number of private banks. These came to be known as
New Generation tech-savvy banks, and included Global Trust Bank (the first of such new
generation banks to be set up), which later amalgamated with Oriental Bank of
Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move,
along with the rapid growth in the economy of India, revitalized the banking sector in
India, which has seen rapid growth with strong contribution from all the three sectors of
banks, namely, government banks, private banks and foreign 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.

Currently (2007), banking in India is generally fairly mature in terms of supply, product
range and reach-even though reach in rural India still remains 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. The Reserve Bank of India is an autonomous
body, with minimal pressure from the government. The stated policy of the Bank on the
Indian Rupee is to manage volatility but without any fixed exchange rate-and this has
mostly been true.

With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector-the demand for banking services, especially retail
banking, mortgages and investment services are expected to be strong. One may also
expect M&As, takeovers, and asset sales.

In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake
in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor
has been allowed to hold more than 5% in a private sector bank since the RBI announced
norms in 2005 that any stake exceeding 5% in the private sector banks would need to be
vetted by them.

In recent years critics have charged that the non-government owned banks are too
aggressive in their loan recovery efforts in connection with housing, vehicle and personal
loans. There are press reports that the banks' loan recovery efforts have driven defaulting
borrowers to suicide.

The merger of State Bank of India’s remaining five associate banks

may get delayed as the government is keen that the amalgamation
takes place in a staggered manner. The finance ministry is also likely
to seek from the State Bank of India details on the cost of merging the
remaining associates.

After the State Bank of Indore’s merger with SBI became effective last
week, SBI chairman OP Bhatt had said the bank will soon discuss with
the government on the process of merging other associate banks.
Shares of the three listed associate banks, the State Bank of
Travancore, the State Bank of Bikaner and Jaipur (SBBJ) and the State
Bank of Mysore, had surged around 35% on rumours of government
agreeing to the merger proposal.

“There is a cost involved in the merger and some associates are listed
on bourses. A definite idea from the bank on the resources required,
will smoothen the process,” said a senior finance ministry official. Out
of the five associate banks, SBBJ, State Bank of Mysore and State
Bank of Travancore are listed. The unlisted ones are State Bank of
Patiala and State Bank of Hyderabad.

According to a senior SBI official, there would be no delay in the

amalgamation of State Bank of Patiala or Hyderabad, and the
government in-principle agrees with SBI’s consolidation move. “We
haven’t send any formal proposal so far. It will be done on a case to
case basis in consultation with the management and unions of
associate banks,” he said.

SBI had earlier submitted a proposal indicating that it would need

around Rs 39,000 crore for the next three financial years for the
purpose of expansion and mergers, if any. “We would like that SBI
should first take on the unlisted associate banks as there will be less
complications.

Also, an assessment needs to be done if there are any remaining

issues with associate banks which have been merged,” the official said.
State Bank Of Indore was the latest bank, where the government had
approved the merger, besides State Bank of Saurashtra, which was
the first of the seven associates to be merged.

After announcing the first quarter results, Mr Bhatt had said the bank
may raise Rs 20,000 crore through a rights issue in this fiscal only. SBI
in its earlier proposal had indicated that it may raise money through
equity or hybrid debt issues, which will help it to maintain a capital
adequacy ratio of 13%.

The bank is also exploring Upper Tier-I and Lower Tier-II subordinate
debt issues. “Other instruments like preference stocks can also be
explored,” the proposal had mentioned. The bank had reported a 25%
growth in its net profit for the first quarter ending June 30, 2010. The
bank recorded a business growth of 12.62% at Rs 1,65,769 crore at
the end of June this year.
Banks to switch to Base Rate system from for Benchmark Prime
Lending Rate (BPLR) system from July 01, 2010

April 09, 2010: Reserve Bank of India had constituted a Working Group on Benchmark Prime
Lending Rate (Chairman: Shri Deepak Mohanty) to review the present benchmark prime lending
rate (BPLR) system and suggest changes to make credit pricing more transparent. The Working
Group submitted its report in October 2009.

Reserve Bank of India has decided that banks will switch over to the system of Base Rate. The
BPLR system, introduced in 2003, fell short of its original objective of bringing transparency to
lending rates. This was mainly because under the BPLR system, banks could lend below BPLR.
For the same reason, it was also difficult to assess the transmission of policy rates of the Reserve
Bank to lending rates of banks. The Base Rate system is aimed at enhancing transparency in
lending rates of banks and enabling better assessment of transmission of monetary policy.
Accordingly, the following guidelines are issued for implementation by banks.

Base Rate System

The Base Rate system will replace the BPLR system with effect from July 1, 2010. Base Rate
shall include all those elements of the lending rates that are common across all categories of
borrowers. Banks may choose any benchmark to arrive at the Base Rate for a specific tenor that
may be disclosed transparently. An illustration for computing the Base Rate is set out in the
Annex. Banks are free to use any other methodology, as considered appropriate, provided it is
consistent and is madeavailable for supervisory review/scrutiny, as and when required.

Banks may determine their actual lending rates on loans and advances with reference to the
Base Rate and by including such other customer specific charges as considered appropriate.

In order to give banks some time to stabilize the system of Base Rate calculation, banks are
permitted to change the benchmark and methodology any time during the initial six month period
i.e. end-December 2010.

The actual lending rates charged may be transparent and consistent and be madeavailable for
supervisory review/scrutiny, as and when required.

Base rate introduction unlikely to pressurise bank

profitability, says Crisil

CRISIL Ratings believes that introduction of the base rate mechanism in India’s banking
system, with effect from July 1, 2010, will enhance competition in the short-term lending
space. Issuance volumes in the debt capital markets are also likely to increase as the highly
rated corporates begin to shift towards these markets. Banks with competitive base rates and
efficient treasury operations are well placed to benefit from the new scenario. However,
competitive pressures are unlikely to impact the overall profitability of the banking system
materially. The base rate system is also expected to enable banks to respond more efficiently
to monetary policy measures.

CRISIL Ratings expects a change in the competitive landscape for short-term corporate
lending, following the implementation of the base rate mechanism. The new mechanism will
limit banks’ flexibility to provide finer rates. Says Pawan Agrawal, Director, CRISIL Ratings,
“We believe that the highly rated corporates availing short-term loans (estimated at 7 to 10 per
cent of total corporate loans) will look to transit to the more attractive debt capital markets
(through short-term instruments), and choose banks with lower base rates.”

The base rate for public sector banks is in the range of 7.5 per cent to 8.25 per cent, while that
for private sector and foreign banks is lower — by 50-100 basis points (bps). CRISIL Ratings
believes that the large private sector banks with more competitive base rates are, therefore,
now relatively better placed to garner market share in the short-term corporate lending space.
However, public sector banks with superior treasury operations can partially offset competitive
pressures in the short-term lending segment by subscribing to the debt market issuances of
corporates.
 In the long-term lending space, however, a material shift in market share is unlikely: CRISIL
Ratings believes that the banks will set lending rates that are near the current levels.
However, corporates with strong credit risk profiles and high ratings will be better placed than
other players to negotiate rates with the banks. “Ratings may become strong differentiators for
corporates over the near to medium term”, adds Mr. Agrawal.

Despite the expected increase in competition in the short-term lending space, implementation
of the base rate system is unlikely to have a significant impact on banks’ interest spreads.
Says Suman Chowdhury, Head, CRISIL Ratings “Banks have flexibility to control other loan-
pricing elements, including tenor and credit risk premiums, and product-specific operating
costs. This will provide the banks with some cushion to protect their interest spreads.”

According to a recently published report from CRISIL Research, the average yield on bank
advances is expected to decline by 10-15 bps over the next two years. Other conclusions of
the report are that the base rate system will require banks to be more transparent in their loan
pricing methodology, that borrowers with healthy credit profiles will now negotiate for finer
pricing, and that SME and retail borrowers, who constitute a significant share of outstanding
bank advances (at around 33 per cent), will be the biggest beneficiaries of the new system.
Applicability of Base Rate

All categories of loans should henceforth be priced only with reference to the Base Rate.
However, the following categories of loans could be priced without reference to the Base Rate:
(a) DRI advances (b) loans to banks’ own employees (c) loans to banks’ depositors against their
own deposits.

The Base Rate could also serve as the reference benchmark rate for floating rate loan products,
apart from external market benchmark rates. The floating interest rate based on external
benchmarks should, however, be equal to or above the Base Rate at the time of sanction or
renewal.

Changes in the Base Rate shall be applicable in respect of all existing loans linked to the Base
Rate, in a transparent and non-discriminatory manner.

Since the Base Rate will be the minimum rate for all loans, banks are not permitted to resort to
any lending below the Base Rate. Accordingly, the current stipulation of BPLR as the ceiling rate
for loans up to Rs. 2 lakh stands withdrawn. It is expected that the above deregulation of lending
rate will increase the credit flow to small borrowers at reasonable rate and direct bank finance will
provide effective competition to other forms of high cost credit.

Reserve Bank of India will separately announce the stipulation for export credit.

This morning, the Reserve Bank released its Second Quarter Review of Monetary Policy for
2010-11. At the heart of the policy was a further increase in the repo and reverse repo rates by 25
basis points each. Accordingly, the repo rate stands raised to 6.25 per cent and the reverse repo
rate to 5.25 per cent. The cash reserve ratio (CRR) has been left unchanged at 6 per cent of net
demand and time liabilities (NDTL) of banks.

2. With this increase, since we started reversing the monetary policy stance in March 2010, the
repo rate has increased by 150 basis points and the reverse repo by 200 basis points.

Considerations Behind Policy Move

3. As always, we had taken into account both global and domestic macroeconomic situation in
calibrating this policy move. In particular, we were guided by three considerations.
Domestic growth drivers are robust which should help absorb to a large extent the negative
impact of any slowdown in global recovery.

Inflation and inflationary expectations remain high as both demand side and supply side factors
are at play. Given the spread and persistence of inflation, demand-side inflationary pressures
need to be contained and inflationary expectations anchored.

Even though a liquidity deficit is consistent with our anti-inflation stance, it needs to be contained
within a reasonable limit to ensure that economic activity is not disrupted.

Global Outlook

4. To start with, a brief comment on the global economy. The fragile and uneven nature of the
recovery and large unemployment in advanced economies raise concerns about the sustainability
of the global turn around. The slowing momentum of recovery has prompted the central banks of
some advanced economies to initiate (or consider initiating) a second round of quantitative easing
to further stimulate private demand. While the ultra loose monetary policy of advanced economies
may benefit the global economy in the medium-term, in the short-term it will trigger further capital
inflows into emerging market economies (EMEs) and put upward pressure on global commodity
prices.

Indian Economy

Growth

5. Turning to domestic outlook, the economy is operating close to the trend growth rate, driven
mainly by domestic factors. The normal South-West monsoon and its delayed withdrawal have
boosted the prospects of both kharif and rabi agricultural production which should also stimulate
rural demand. Most industrial and service sector indicators also point towards sustained growth.

6. Taking into account the good performance of the agriculture sector, and a range of indicators
of industrial production and service sector activity, the baseline projection of real GDP growth for
2010-11, for policy purposes, is retained at 8.5 per cent.

Inflation

7. Let me now move to the vital issue of inflation conditions. Notwithstanding some moderation in
recent months, headline inflation remains significantly above its medium-term trend, and well
above the comfort zone of the Reserve Bank. Food inflation has not shown the expected post-
monsoon moderation and has remained persistently elevated for over an year now, reflecting in
part the structural demand-supply mismatches in several commodities. This has elevated inflation
expectations. The risks of expectations spilling over into prices of other commodities are
significant when the economy is growing close to trend. That could potentially offset the recent
moderation.

8. Even as non-food manufacturing inflation has moderated, it remains above its medium-term
trend. The new WPI series released in September 2010 is a better representative of commodity
price levels with an updated base (2004-05=100) and wider coverage of commodities. When we
compare the old and new WPI series, inflation at the aggregate level over the medium-term is
similar under both series, but there are differences at a disaggregated level. Inflation in primary
articles, especially food articles, in the new series has been significantly higher than in the old
series, whereas for manufactured products, it has been somewhat lower.
9. Going forward, the inflation outlook will be shaped by three factors: (i) the evolution of food
price inflation; (ii) global commodity prices; and (iii) demand pressures stemming from sustained
growth amidst tightening capacity constraints in many industries.

10. On balance, inflation is expected to moderate from the present elevated level, reflecting in
part, some easing of supply constraints and concerted policy action. In its July Review, the
Reserve Bank made a baseline projection of WPI inflation for March 2011 of 6 per cent under the
old series of WPI. The baseline projection of WPI inflation for March 2011 has been placed at 5.5
per cent under the new series. This is equivalent to 6 per cent under the old series. Effectively,
this means that the Reserve Bank’s inflation projection remains unchanged from that made in its
July 2010 Review.
Second Quarter Review of the Monetary Policy for 2010-11
Press Statement by Dr. D. Subbarao, Governor-2nd November 2010

Monetary and Liquidity Aggregates

11. The overall liquidity situation has been in the news over the last few weeks. Let me explain
the evolving situation and the underlying dynamics.

12. The present tight liquidity is a result of both structural and frictional factors. On the structural
side, the deposit growth rate of the banking system has been sluggish even as the credit growth
improved. On the frictional side, government cash balances had built up as a result of more than
anticipated tax receipts. On top of it, there were large capital outflows on account of refund of
over-subscription of Coal India IPO.

13. Tight liquidity conditions are admittedly desirable from the viewpoint of inflation management,
but there are legitimate concerns about the deficit as the injection through the LAF window had
become too large in recent weeks, in excess of the Reserve Bank’s comfort zone of (+/-) 1 per
cent of NDTL

14. With a view to alleviating the frictional liquidity pressure, the Reserve Bank decided to
conduct a second LAF (SLAF) on a daily basis and also allowed banks to avail additional liquidity
support under the LAF to the extent of up to 1 per cent of their NDTL up to November 4, 2010. In
order to address the structural liquidity problem, earlier today, the Reserve Bank announced an
OMO for purchase of government securities amounting to `12,000 crore.

15. In view of the current assessment of the growth-inflation dynamics, It is expected that
monetary aggregates will evolve along the projected trajectory indicated in our July Review.
Accordingly, for policy purposes, we have retained the earlier projections of money supply (M3) at
17 per cent and of non-food bank credit growth at 20 per cent. As always, these numbers are
indicative projections and not targets.

External Sector

16. Let me now move to external sector management which has assumed a lot of importance in
the recent period owing to global developments. The current account deficit in the balance of
payments widened in the first quarter of 2010-11. If the current trend persists, the current account
deficit as a percentage of GDP for the full year will be significantly higher than in last year. It is
generally perceived that a current account deficit above 3 per cent of GDP is difficult to sustain
over the medium-term. The challenge, therefore, is to rein in the deficit over the medium-term and
finance it in the short-term. The medium-term task has to receive policy focus from both the
Government and the Reserve Bank. The short term task is to see that the current account is fully
financed while ensuring that capital flows are not far out of line with the economy’s absorptive
capacity and that the component of long-term and stable flows in the overall capital flows is high.

Capital Flows

17. In the context of today’s increases in policy rates, let me now turn to another important issue.
It has often been argued that the widening of interest rate differential between the domestic and
international markets will result in increased debt-creating capital flows. While it is true that large
interest rate differential makes investment in domestic debt instruments and external borrowings
by domestic entities more attractive, we need to keep in view three aspects in the Indian context.
First, the economy’s capacity to absorb capital flows has expanded as reflected in the widening of
the current account deficit. Second, despite the already large differential between domestic and
international interest rates, capital flows in the recent period have been predominantly in the form
of portfolio flows into the equity market. This suggests that the interest rate differential is not the
only factor that influences capital flows. Third, in line with our policy of preferring equity to debt-
creating flows, we still maintain some controls in respect of debt flows.

Second Quarter Review of the Monetary Policy for 2010-11

Press Statement by Dr. D. Subbarao, Governor- 2nd November 2010

Risk Factors

18. Let me indicate some of the important risks to the growth and inflation outlook.

First, the main downside risk to growth emanates from the prospects of a prolonged, slow and
halting recovery in advanced economies which would adversely affect the growth performance of
EMEs, including India.

Second, inflationary pressures may accentuate due to the structural component in food inflation
while demand side pressures may accentuate due to capacity constraints in many industries and
rising global commodity prices.

Third, given the weak recovery, some advanced economies are in the process of resorting to
another round of quantitative easing that could trigger capital flows into EMEs, including India.
Large capital flows beyond the absorptive capacity of the economy could pose a major challenge
for exchange rate and monetary management.

Fourth, the widening of the current account deficit raises concerns given the uncertainty
associated with international capital flows.

Fifth, asset prices in India, as in many other EMEs, have risen sharply in a short time which is a
cause for concern.

Monetary Policy Stance

19. The current stance of monetary policy is intended to :

Contain inflation and anchor inflationary expectations, while being prepared to respond to any
further build-up of inflationary pressures.

Maintain an interest rate regime consistent with price, output and financial stability.
Actively manage liquidity to ensure that it remains broadly in balance, with neither a surplus
diluting monetary transmission nor a deficit choking off fund flows.

Expected Outcomes

20. Today’s monetary policy actions are expected to:

Sustain the anti-inflationary thrust of recent monetary actions and outcomes in the face of
persistent inflation risks.

Rein in rising inflationary expectations which may be aggravated by the structural nature of food
price increases.

Be moderate enough not to disrupt growth.

21. Let me reiterate that the exit from expansionary monetary policy since October 2009 has
been calibrated on the basis of India’s specific growth-inflation dynamics in the broader context of
persistent global uncertainty. The Reserve Bank will continue to closely monitor both global and
domestic macroeconomic conditions. We will take action as warranted with a view to mitigating
any potentially disruptive effects of lumpy and volatile capital flows and sharp movements in
domestic liquidity conditions, consistent with the broad objectives of price and output stability.

22. Based purely on current growth and inflation trends, the Reserve Bank believes that the
likelihood of further rate actions in the immediate future is relatively low. However, in an uncertain
world, we need to be prepared to respond appropriately to shocks that may emanate from either
global or domestic environment.

Developmental and Regulatory Polices

23. Let me now turn to developmental and regulatory issues. The thrust of the regulation by the
Reserve Bank in recent years has not only been on strengthening the financial system, but also
on developing financial markets, promoting financial inclusion, improving credit delivery,
especially to the SME sector, improving customer service and strengthening the payment and
settlement systems. The Reserve Bank, therefore, will continue to pursue reforms in these areas
so as to enhance the efficiency and stability of the financial system.
Second Quarter Review of the Monetary Policy for 2010-11
Press Statement by Dr. D. Subbarao, Governor- 2nd November 2010

24. I will highlight a few measures, we have taken or plan to take in these areas.

Financial Stability

Releasing the second financial stability report in December 2010. Going forward, financial stability
report will be published in June and December every year.

Interest Rates

Preparing a discussion paper, which will delineate the pros and cons of deregulating the savings
bank deposits interest rate. Financial Market Products

Permitting settlement of repo in corporate bonds on a T+0 basis in addition to the existing T+1
and T+2 basis. Credit Delivery and Financial Inclusion

Allowing regional rural banks (RRBs) to open branches in tier 3 to tier 6 centres as identified in
the Census 2001(with population up to 49,999), subject to fulfilling certain conditions.

Opening sub-offices of the Reserve Bank in the remaining six states of the North East, viz.,
Arunachal Pradesh, Nagaland, Manipur, Mizoram, Tripura and Meghalaya, in a phased manner.

Initiating several measures to strengthen the role of urban co-operation banks (UCBs) such as:

extending area of their operations;

liberalising branch licensing policy for well managed and financially sound UCBs;

allowing well managed and financially sound UCBs to engage business correspondents
(BCs)/business facilitators (BFs);

allowing licensed UCBs the facility of INFINET membership, current and SGL accounts with the
Reserve Bank; and

allowing RTGS membership to well managed and financially sound UCBs having a minimum net
worth of ` 25 crore.

Regulatory Measures

Prescribing the loan to value (LTV) ratio of not exceeding 80 per cent in respect of housing loans
hereafter.

Increasing the risk weight for residential housing loans of ` 75 lakh and above, irrespective of the
LTV, to 125 per cent.

Increase the standard asset provisioning by commercial banks for all housing loans with teaser
rates to 2 per cent.

Stipulating prudential limits to regulate the investments of banks in companies engaged in forms
of business other than financial services. Banks will be required to review their investments in
such companies and be compliant with the guidelines as per the roadmap to be laid down.

Implementing the recommendations of the Internal Group on Supervision of Financial

Conglomerates (FCs) on (i) capital adequacy for FCs; and (ii) intra-group transactions and
exposures in FCs.

Taking appropriate steps to fully align the corporate governance practices in banks in India with
the principles enunciated by the Basel Committee on Banking Supervision (BCBS).

Issuing final guidelines on compensation practices by banks by end-December 2010.

Putting the draft guidelines on licensing of new banks in public domain by end-January 2011 for
public comments.

Institutional Measures

Increasing the threshold limit for real time gross settlement system (RTGS) transactions from the
present limit of ` 1 lakh to ` 2 lakh.

Accepting the report of the Group on next generation RTGS.

Planning the next roll out of cheque truncation system in March 2011 at Chennai.

Discussions with banks

25 Banks welcomed the Reserve Bank’s policy stance. They agreed that the monetary measures
announced by the Reserve Bank today were appropriate in the current domestic growth-inflation
dynamics. Apart from monetary measures, discussions with banks focused on four specific
issues, i.e., (i) liquidity situation; (ii) housing credit, price and risk; (iii) customer service; and (iv)
external sector management. While appreciating the liquidity easing measurers announced
recently, banks indicated that steps are required to ease structural liquidity. Welcoming the
stipulation of the loan to value ratio and increased risk weight in housing loans, some banks felt
that the practice of offering lower interest rates in the initial period of housing loans cannot be
equated with teaser loans as the risk in such loans is not different from those offered at floating
rate loans. Banks reiterated that they will continue to strive for improved customer service. Banks
shared the Reserve Bank’s concern that the component of stable capital flows in the overall flows
should be increased to address the concerns of financing the widening current account deficit."

Banking System gasping for liquidity, says Assocham

December 24, 2010 : The economy will continue to face tighter interest rates after a small gap,
for the major part of 2011 as inflation still hovers much over the estimated levels and liquidity
getting weaker due to larger than expected credit growth and lower deposit growth due to
almost negative yield and government borrowing not seeing any halt, says assocham

Faster credit growth has put pressure on the liquidity of Banks . This crunch is likely to slip to
year 2011 as the high inflation rate has dissuaded investors to park their funds with banks
which is reflected in low deposit growth. The RBI recent mid quarter monetary policy has
supported for additional liquidity measures to sustain growth in credit off take and sustain the
growth momentum.

The reduction in SLR to 24%, additional open market operations (OMO) to repurchase
securities within the next month to the extent of Rs 48,000 Crores, reduction in government
borrowings to Rs 6000 Crores as against Rs 11,000 Crores per week, are welcome steps to
ease the liquidity mismatch. However the rising food inflation which again crossed double
digit, are areas of concern and worry,

Assocham strongly feels that the large borrowings by Banks from RBI repo window to the
extent of Rs 1.59 lakh Crores lately, has shown extremely high demand of funds in the
growing economy with expected GDP racing towards 9% by 31st March, 2011. It is also
surprising that RBI holds credit balance of around Rs 1.00 lakh Crores in current account on
government account. It is expected that the year-end payments and disbursements by the
government would inject additional liquidity in the system.

The large outflows on Advance Tax, 3G Spectrum auction as well as increased deposit
interest rates by commercial banks is likely to return to the system and is a very positive
impact on enhanced deposits and ease the large liquidity demand on account of expanded
credit off take.
 The inflationary pressures as well as expectations are again building up with commodity prices
all over the world shooting up as well as Crude touching 90 US $ per barrel. This is very
positively put pressure on RBI to go in for tighter monetary policy instance as the Inflation
continues to be far in excess of tolerance level of 5.5% p.a. as projected by the end of the
current fiscal year.

The days ahead are extremely dicey with Growth estimated to be around 9% p.a and inflation,
one of the highest in the world for consistently long period. The options with RBI are limited as
the growth is not likely to be sacrificed for inflation. Hence there is every likelihood of policy
rates to inch up in the next Monitory policy announcement on 16th Jan., 2011 by RBI.

A clearer picture will emerge only if the inflation is reined and expectations are drowsed which
though expected to be worry some, will force RBI to increase policy rates instance.

The Reserve Bank of India established on April 1, 1935 is the apex body for regulating and
supervising the banking and financial institutions in India.
It is the responsibility of Reserve Bank of India to formulate, implement and monitor the
monetary policy.

In order to discharge this responsibility successfully RBI has formulated certain reserve ratios
and key policy rates.

The reserve ratios are as follows:

Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)

Cash Reserve Ratio (CRR):- CRR refers to the amount of cash banks are required to park in
their specified current account maintained with RBI.

Statutory Liquidity Ratio (SLR):- Statutory liquidity ratio refers to the percentage of time &
demand liabilities banks are required to keep with themselves in the form of cash (book
value), gold (current market value) and balances in unencumbered approved securities

If RBI decides to increase the percent of CRR & SLR, the available amount with the banks
comes down. Thus, RBI uses the reserve ratios to drain out the excessive liquidity from the
market.

The policy rates are as follows:

Bank rate
Repo Rate
Reverse Repo Rate

Bank Rate:- Bank rate is the rate of interest charged by RBI on the loans and advances it
provides to commercial banks & financial institutions. It is also called as the discount rate.

Repo Rate:- It is the rate of interest at which commercial banks borrow money from RBI.

Reverse Repo Rate:- It is the rate of interest at which RBI borrow money from commercial
banks.

A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo
rate increases borrowing from RBI becomes more expensive. Whereas an increase in Reverse
repo rate can cause the banks to transfer more funds to RBI due to this attractive interest
rates. It can cause the money to be drawn out of the banking system.

This fine tuning of the monetary tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate
allow RBI to fulfill its objective of maintaining price stability and ensuring adequate flow of
credit in the system.