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The Reserve Bank of India (hereinafter, RBI), also known as the Central Bank of India, was established by the Reserve Bank Act, 1934. The Preamble to Act of 1934 promulgates the objective of RBI which is “to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage”. Since then, as the dynamics of the Indian economy changes, roles of RBI changes.
As per the Act, the key role of RBI is to ensure stability of money which in turn preserves confidence in the value of the country’s money or we can say sustains the purchasing power of the currency. Eventually, this helps in sphering around the 6 stable expectations of inflation, irrespective of the origin of inflation. Additionally, the RBI has two other important considerations; inclusive growth by promoting financial inclusion, as well as financial stability.
In a country where a large section of the society is still poor, inclusive growth assumes great significance. Access to finance is essential for poverty alleviation and reducing income inequality. As the central bank of a developing country, the responsibilities of the RBI also include the development of financial markets and institutions. To be precise, broadening and deepening of the structure of financial markets and increasing their liquidity and resilience resulting in their allocation and absorption of the risks in financing India’s growth is a chief grail of RBI.
Recent development to ease the impact of lockdown
In light of the recent pandemic created by the threats of corona virus, the RBI has noted the expected impact on the Indian economy and thus, to combat it, has reduced the key interest rate by 75 bps and allowed equated monthly instalments (EMIs) to be deferred by three months. In addition, the repo rate was lowered by 75 bps making it 4.4% and the reverse repo rate was lowered by 90 bps point making it 4%. The higher reduction in the reverse repo rate was objected to encourage banks to lend more rather than keeping their excess with the RBI.
The step was taken on the third day of nationwide lockdown because of which the financial market faced instability. The governor, Shaktikanta Das, has expressed the concern by introducing war like effort inclusive of both conventional and unconventional steps to fight against this crisis.
Additionally, RBI has lowered the cash reserve ratio of banks which injected ₹1.37 lakh crore liquidity into the market making it total infuse of ₹3.74 lakh crore into the banking system when accompanied with other measures.
Needless to say that, RBI has cushioned the market for borrowers and lenders by allowing banks to defer payment of EMIs on home, car, personal loans and credit card dues for three months up till May 31st, 2020. There wouldn’t be any implication on the credit score of the borrowers because non-payment will not lead to non-performing asset classification by banks. In pursuance of the step taken by RBI, State Bank of India, the largest lender of the nation, reduced the repo rate by 75 bps.
Interest rate on external benchmark linked loans was reduced from 7.8% to 7.05% and those are linked to repo rate were reduced to 6.65%. Ensue, EMIs on Home Loan accounts are now as cheap as approx. ₹52/1 lakh on a loan of 30 years. The bank has also reduced the retail fixed deposit rate by 20-50 bps across all tenures. Bulk deposit rates were cut by 50 bps to 100 bps across tenors.
Significance of this development
By this giant step to combat the outbreak, RBI used its monetary measures in such a way that gives relief to the financial market till everything comes back to square one. The new repo rate, which is 4.4%, will be applicable on all term loans ranging from home, auto, personal, crop and retail. Debtors are authorised to grant a moratorium of three months on payments in installments like EMIs, credit card dues, bullet payments and interest and principal payments, etc which are due as of March 1st, 2020.
It is not to be misunderstood that the loans are waived because the tenure of them will be extended by 3 months after the moratorium. All term loans like agricultural term loans, retail and crop loans and working capital payment will be covered by the three-month moratorium. This also means that there would be no waiving of interest as it will accrue on the outstanding payments. At the end of 3 months, interest shall be added to the outstanding loan. To ensure stability, RBI has introduced Rs. 3.74 lakh crore liquidity into the financial system.
The scheme will apply to only those who won’t be able to make their outstanding payments on time. Borrowers with standing instructions to deduct EMIs toward borrowings will have to approach banks to seek the benefit.
Banks have discretion in marking the limits on working capital and can grant relief wherever possible on case to case basis. The businesses may request the Bank to re-assess their Working Capital requirements on account of disruption of their cash flows or elongation of cycle of their Working Capital. Businesses may also come forward requesting curtail in margin on NFB facilities or also relief in Security wherein bank will make decision on the basis of the genuineness of the request.
It is expected that these measure would lead to reduced lending rates. The 3 month extension would provide succor to banks as their NPA levels would not rise up. This might lead to preservation of capital for business rather than using it for provisions. Apart from that, this outbreak also made borrowers incapable in paying back their dues to the banks on time so both the sides of the transaction would take a sigh of relief.
Types of rates decided by RBI
Pursuant to the amendment to RBI Act, 1934, in May 2016, the primary objective of monetary policy is to maintaining price stability while keeping in mind the objective of growth. There are various direct and indirect instruments used for implementing monetary policy including Repo Rate, Reverse Repo Rate, Liquidity Adjustment Facility (LAF), Marginal Standing Facility (MSF), Corridor, Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open Market Operations (OMOs) and Market Stabilization Scheme (MSS) . They are briefly explained below:
Repo rate: The interest rate at which RBI grants loans to banks against government securities or any other collateral under the Liquidity Adjustment Facility (LAF). The term ‘Repo’ stands for ‘Repurchasing Options’. This tool is used to control inflation. Increased repo rate provides disincentive to commercial banks to borrow from RBI which in turns absorbs the liquidity from the market.
Reverse repo rate: The interest rate at which RBI borrows loan from commercial banks against the collateral of government securities under the LAF. This tools helps in controlling the money supply in the economy.
Liquidity Adjustment Facility (LAF): The LAF comprises overnight as well as term repo auctions by way of repurchase agreements. This helps banks in the management of liquity of daily basis by borrowing and lending quickly in cases of emergency against government securities. This consist of repo and reverse repo operations to inject and absorb money from the market. The transactions under LAF are entered online via Real Time Gross Settlement method.
Marginal Standing Facility (MSF): A facility under which commercial banks can borrow additional amount of overnight money from the RBI in case of emergency when there is no scope of inter-bank liquidity. This provides a safety wall against unforeseen contingent liquidity risks to the banking system.
Corridor: the corridor system serves as the basis of interbank interest rates as the MSF rate and reverse repo rate determine the corridor for the regular transactions in the average call money rate.
Bank rate: the rate at which the RBI grants loans to domestic scheduled commercial banks by buying or rediscounting bills of exchange or other commercial papers. Section 49 of RBI Act, 1934 provides for publication of this rate. This rate works parallel to the MSF rate which is why it changes automatically when MSF rate changes alongside policy repo rate changes. Lower the bank rate, higher the money supply in the market and vice versa. It is to be noted that repo rate is charged against the repurchase of securities sold by the commercial banks. Repo rate is usually kept lower than the bank rate.
Cash Reserve Ratio (CRR): All Central banks of all the nations emphasise the importance of keeping reserves with them made by domestic commercial banks to control inflation, money supply and liquidity in the economy. CRR is a part of the same reserve under which RBI mandates commercial banks to keep a part of their cash as reserve either in bank’s vault or with RBI, however, they do not get any interest on this. If the CRR is 5%, the banks are required to maintain 5 percent of their Net Demand and Time Liabilities (NDTL) as cash reserves. They are strictly to be maintained in cash and cannot be used in lending or borrowing.
Statutory Liquidity Ratio (SLR): It is also a part of reserve that a commercial bank has to maintain. However, unlike CRR this can be maintained by gold, government securities or any other liquid asset along with cash. Higher SLR controls the inflation whereas lower SLR fuels the money supply to grow. SLR is mentioned and publisher under Section 24 (2A) of Banking Regulation Act, 1949. This also encourages commercial banks to invest in government bonds.
Open Market Operations (OMOs): This allows dual transactions of sale and purchase of government securities by RBI in the open market in such quantities that affects the money supply in the economy. This is a tool used by RBI to manipulate rates and cope with unwanted situations in the financial market.
Market Stabilisation Scheme (MSS): This instrument for monetary policy was introduced in 2004 to intervene in the surplus liquidity arising from large capital inflows. Under this scheme, RBI sells short term government bonds to absorb the excess liquidity. The bonds so issued under this scheme are called Market Stabilisation Bonds (MSBs). RBI, thus, holds debts against the government of value equal to that of MSBs. The money obtained herein cannot be used by the government in the economy but are maintained with RBI.
It is disheartening to observe that India is looking at the worst annual rate of GDP expansion since the global financial crisis of 2008-09. A further threat is also expected by economists due to the COVID-19 outbreak.
However, as rightly quoted by the RBI Governor, the prima concern is safeguarding Indian economy via “strong and purposeful action”. Thus, there is an imminent call for all the market players to introduce such measures that are on the lines of RBI to combat the impact of this lockdown. Since February, the RBI has already injected Rs 2.7 lakh crore into the system, which on addition with other liquid inflows of RBI, makes 3.2 % of the GDP.
The central bank will continue to be cautious and take all necessary and adequate measure to subjugate the threat of coronavirus on the economy. The central bank will sustain its accommodative stance of policy as long as necessary to rejuvenate development along with sustaining inflation within expected targets.
Author: Vidhi Saxena from National Law Institute University, Bhopal.
Editor: Tamanna Gupta from RGNUL, Patiala.