INTRODUCTION 

The sense in which we today use the term banking has its origin in the western world. It was introduced in India by the British rulers, way back in the 17th century.Since then a number of changes have taken place in the sector and today Indian banks are among the finest in the emerging market economics well-directed towards becoming global. 

NBFCS

Bank is a financial institution engaged primarily in mobilising deposits and forwarding loans The deposits and loans are highly differentiated in nature. Banks are regulated by the Central bank of the country—in case of India, the RBI (Reserve Bank of India). The another category of financial institution—the non-bank—is almost similar in its functions but main difference (though, highly simplified) being that it does not allow its depositors to withdraw money from their accounts. NBFCs (Non-Banking Financial Companies) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and co-operative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc. They can not have certain activities as their principal business—agricultural, industrial and sale-purchase or construction of immovable property.
They raise funds from the public, directly or indirectly, and lend them to ultimate spenders. They advance loans to the various wholesale and retail traders, small-scale industries and selfemployed persons. Thus, they have broadened and diversified the range of products and services offered by a financial sector. Gradually, they are being recognised as complementary to the banking sector due to their—
(i) customer-oriented services;
(ii) simplified procedures;
(iii) attractive rates of return on deposits; and
(iv) flexibility and timeliness in meeting the credit needs of specified sectors.
RBI, the regulator of the NBFCs, has gives a very wide definition of such companies (a kind of ‘umbrella’ definition)—“a financial institution formed as a company involved in receiving deposits or lending in any manner.” Based on their liability structure, they have been classified into two broad categories:
1. deposit-taking NBFCs (NBFC-D), and
2. non-deposit taking NBFCs (NBFC-ND).
It is mandatory for a NBFC to get itself registered with the RBI as a deposit taking company. For registration they need to be a company (incorporated under the Companies Act, 1956) and should have a minimum NOF (net owned fund) ?2 crore. To obviate dual regulation, certain category of the NBFCs which are regulated by other financial regulators are exempted from the regulatory control of the RBI:
(i) venture capital fund, merchant bank, stock broking firms (SEBI registers and regulates them);
(ii) insurance company (registered and regulated by the IRDA);
(iii) housing finance company (regulated by the National Housing Bank);
(iv) nidhi company (regulated by the Ministry of Corporate Affairs under the Companies Act, 1956); 
(v) chit fund company (by respective state governments under Chit Funds Act, 1982). 

 RESERVE BANK OF INDIA

 In the wake of the banking crisis of early 20th century, world felt a need of central banking body for the first time. Following the global clue, in India also such a body, the Reserve Bank of India , was set up on April 1, 1935 in accordance with the provisions of the RBI Act, 1934, in Calcutta (got shifted to Bombay in 1937). Set up under private ownership like a bank it was given two extra functions—regulating banking industry and being the banker of the Government. To better serve the purpose, during mid-1940s, a view emerged across the world in favour of a government-owned central bank—and governments started taking them over.  “To regulate the issue of Bank notes and 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; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy, to maintain price stability while keeping in mind the objective of growth.” As per the changing needs of time, the RBI Nationalisation Act of 1949 has been amended several times by the Government and its functions broadened. Its current functions may be
summarised objectively in the following way—
(i) Monetary Authority: It includes formulation, implementation and monitoring of the monetary policy. The broad objective is—maintaining price stability keeping in mind the objective of growth. Today, under price stability it stabilises the wholesale price index (WPI) and targets the consumer price index (CPI-C).
(ii) Currency Authority: It includes issuing of new currency notes and coins (except the currency and coins of rupee one or its denominations, which are issued by Ministry of Finance itself) as well as exchanging or destroying those ones which are not fit for circulation This function includes the distribution responsibility of the currencies and coins also (of those ones also which are issued by the Ministry of Finance). The broad objective is—keeping adequate supplies of quality currencies and coins.
(iii) Regulator and Supervisor of the Financial System: It includes prescribing broad parameters of banking operations within which the banking and financial system operates. The broad objective of this function is— maintaining public confidence in the system, protecting depositors’ interest and providing cost-effective banking services to the public.
(iv) Manager of Foreign Exchange: In includes broad functions like—managing the FEMA (Foreign Exchange Management Act, 1999); keeping the Forex (foreign exchange) reserves of the country; stabilising the exchange rate of rupee; and representing the Government of India in the IMF and World Bank (and other international financial agencies of which India is member). Objective of this function is—facilitating external trade and external payments; and promoting orderly development/maintenance of foreign exchange market in the country.
(v) Regulator and Supervisor of Payment and Settlement Systems: It includes functions like introducing and upgrad-ing safe and efficient modes of payment systems in the country to meet the requirements of the public at large. The objective is maintaining public confid-ence in payment and settlement system.
(vi) Banker of the Governments and Banks (known also as the Related Functions): It includes three category of functions— firstly, performing the Merchant Banking functions for the central and state governments; secondly, acting as their Bankers; and thirdly, maintaining banking accounts of the SCBs (scheduled commercial banks)—domestic, foreign, public and private— operating in the country. The broad objectives are enabling governments and the banks mobilise enough liquidity for their functioning under which it lends or manages borrowing plans of the governments and provides shortterm and long-term loans to the banks (as Lender of Last Resort).
(vii) Developmental Functions: Unlike most of the central banks in the world, the RBI was given some developmental functions also. Playing this role, it did set up developmental banks like—IDBI, SIDBI, NABARD, NEDB (North Eastern Development Bank), Exim Bank, NHB. Gradually, the ownership of these banks is being transferred from the RBI to the Government of India (aimed at enhancing regulatory freedom and professionalism of the central bank and enabling the Government to take care of the dynamic requirements of development in a better way).

RBI’s Reserves & Surplus Capital 

In 2019-20, a lot of debate was seen on the issue of reserve transfer of the RBI to the Government. To look into the issue, an expert committee on Economic Capital Framework was set up by the RBI (headed by Bimal Jalan) in 2019, which could advise the manner in which it should share surplus capital with the Government. On its advice, the RBI transferred an amount of ?1.76 lakh crore to the Government and affected several changes related to the issue:

• Giving a clearer distinction between the two components of ‘economic capital’—ealized equity and revaluation balances— the committee recommended that realised equity could be used for meeting all risks/losses as they were primarily built-up from retained earnings, while revaluation balances could be reckoned only as risk buffers against market risks as they represented unrealised valuation gains and hence were not distributable.
• The revaluation balance of the central bank should not be distributed.
• The entire net income can be transferable to the government only if realised equity is above its requirement. If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government.
•  On the issue of the RBI’s economic capital, the committee reviewed the status, need and justification of the various reserves, risk provisions and risk buffers maintained by the RBI and recommended their continuance.
•  On the risk provisioning for market risk, the committee has recommended the adoption of Expected Shortfall (ES) methodology under stressed conditions (in place of the extant Stressed-Value at Risk) for measuring the RBI’s market risk on which there was growing consensus among central banks as well as commercial banks over the recent years.
•  While central banks are seen to be adopting ES at 99 per cent confidence level (CL), the committee has recommended the adoption of a target of ES 99.5 per cent CL keeping in view the macroeconomic stability requirements.
• As per the report, realised equity is also required to cover credit risk and operational risk. This risk provisioning made primarily from ‘retained earnings’ is cumulatively referred to as the Contingent Risk Buffer (CRB) and has been recommended to be maintained within a range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet, comprising 5.5 to 4.5 per cent for monetary and financial stability risks and 1.0 per cent for credit and operational risks.

MONETARY POLICY 

Considered as the most dynamic and sensitive function of a central bank (i.e., RBI in case of India) this macroeconomic policy is related to monetary matters—chiefly aimed at regulating the size and cost of fund/money in the economic system. From being announced twice a year (before slack and busy seasons) today the policy is a bi-monthly affair announced 6 times in a financial year after the monetary policy committee (MPC) came into being in 2016. Committee-based approach to monetary policy is supposed to add value and transparency to monetary policy with statutory responsibility given to the RBI for targeting inflation (CPI-C) while keeping in mind the objective of growth. The MPC (has to meet 4 times minimum every year) has a total of 6 members nominated by RBI and the Ministry of Finance in equal numbers including the RBI Governor as its Chairman who avails the right of casting vote in case of a tie in decisions. 

There are few types of monetary policy stances which keep coming into media from time to time—
(i) Neutral stance means interest rates may move either way—upward or downward.
(ii) Calibrated tightening means interest rates can only move upward.
(iii) Accommodative stance (also known as expansionary stance) means injection of more funds into the financial system. Falling ‘headline inflation’ inspires RBI for it and such a stance is aimed at expansion in lending, investment and growth.
(iv) Contractionary stance means syphoning out of fund from the financial system. Such a stance is generally followed once more than optimum fund is believed to be available in the financial system. At times, it is also aimed at taming inflation in long-term.
(v) Hawkish stance means the contractionary stance aimed at checking inflation from rising (linked to the statutory goals of inflation targeting the ‘headline inflation’).
To put in place the desired kind of monetary policy, RBI uses a range of instruments and tools —a brief description follows:

Cash Reserve Ratio  

Banks operating in the country are under regulatory obligation to maintain ‘reserve ratios’ of two kinds, one of it being the cash reserve ratio (the other being ‘statutory liquidity ratio’). Under it, all scheduled commercial banks operating in the country are supposed to maintain a part of their total deposits with the RBI in cash form as the cash reserve ratio (CRR). The RBI could fix it between 3 to 15 per cent of the ‘net demand and time liabilities’ (NDTL) of the banks. In the wake of the ongoing process of banking reforms, certain changes were affected by the RBI in relation to the ratio since late 1990s—

(i) Aimed at enabling banks to lend more and cut interest rates on loans they offer, in 1999–2000, the RBI started paying banks an interest income on their CRR. The payment of interest was discontinued by late 2007 in the wake of rising prices (to check aggregate demand in the economy).
(ii) The ratio which used to be generally on the higher side, was drastically cut down to 4.5 per cent in 2003 (from the peak of 15 per cent in 1992).
(iii) A major development came in 2007 when by an amendment (in the RBI Act, 1949), the Government abolished the lower ceiling (called ‘floor’) on the CRR and gave the RBI greater flexibility in fixing this ratio. It means, it is now possible for the RBI to fix the CRR below 3 per cent also.  In March 2020, the CRR was 3 per cent & 3 % in 2021 of the NDTL of the banks—one per cent change in it today makes a difference of around ?1.37 lakh crore on the cash flow in the financial system. 

Statutory Liquidity Ratio 

Banks operating in the country are under regulatory obligation to maintain ‘reserve ratios’ of two  kinds, one of it being the statutory liquidity ratio (the other being the ‘cash reserve ratio’). Under it, all scheduled commercial banks operating in the country are supposed to maintain a part of their total deposits (i.e., their NDTL) with themselves in non-cash form (i.e., in ‘liquid assets’)— the ratio could be fixed by the RBI between 25 to 40 per cent. In practice, banks cannot invest this fund in the liquid assets of their choice rather they are forced to invest in the Government securities (i.e., G-Secs) of various kinds. Banks earn income on this investment as per the configuration of their investments in the G-Secs. In the wake of the ongoing process of banking reforms, certain changes were affected by the RBI in relation to the ratio since late 1990s—

(i) The ratio was drastically cut down to 25 per cent (the floor) in 1997 from the existing level of 32 per cent.
(ii) By an amendment (in the RBI Act, 1949) done in 2007, the lower ceiling (the floor) of 25 per cent was removed by the Government. This way, the SLR may be fixed by the RBI below 25 per cent also. Since then the SLR have shown a falling tendency. In March 2020, the SLR was at 18.25 per cent and 18 % in 2021 of the NDTL of the banks. With one per cent change in this ratio today banks either lose or gain choice of investing around a fund of ?1.37 lakh crores. 

Bank Rate 

The interest rate which the RBI charges on its long-term lendings is known as the Bank Rate. The clients who borrow through this route are the Government of India, state governments, banks, financial institutions, co-operative banks, NBFCs, etc. The rate has direct impact on longterm lending activities of the concerned lending bodies operating in the Indian financial system.

The rate was realigned with the MSF (Marginal Standing Facility) by the RBI in February 2012. By March 2020, it was at 4.65 per cent and 4.25% in 2021. 

Repo Rate 

The rate of interest the RBI charges from its clients on their short-term borrowing is the repo rate in India. Basically, this is an abbreviated form of the ‘rate of repurchase’ and in western economies it is known as the ‘rate of discount’. In practice it is not called an interest rate but considered a discount on the dated government securities, which are deposited by institution to borrow for the short term. When they get their securities released from the RBI, the value of the securities is lost by the amount of the current repo rate. The Call Money Market of India (inter-bank market) operates at this rate and banks use this route for overnight borrowings. This rate has direct relation with the interest rates banks charge on the loans they offer (as it affects the operational cost of the banks). The rate was 4.40 per cent in March 2020.
In October 2013, RBI introduced term repos (of different tenors, such as, 7/14/28 days), to inject liquidity over a period that is longer than overnight. It has several purposes to serve— stronger money market, stability, and better costing and signalling of the loan products.  

Reverse Repo Rate

It is the rate of interest the RBI pays to its clients who offer short-term loan to it. At present (March 2020) the rate is at 4.00 per cent. It is reverse of the repo rate and this was started in November 1996 as part of Liquidity Adjustment Facility (LAF) by the RBI. In practice, financial institutions operating in India park their surplus funds with the RBI for short-term period and earn money. It has a direct bearing on the interest rates charged by the banks and the financial institutions on their different forms of loans. This tool was utilised by the RBI in the wake of over money supply with the Indian banks and
lower loan disbursal to serve twin purposes of cutting down banks losses and the prevailing interest rate. It has emerged as a very important tool in direction of following cheap interest regime—the general policy of the RBI since reform process started. 

Marginal Standing Facility (MSF) 

MSF is a new scheme announced by the RBI in its Monetary Policy, 2011–12 which came into effect from May, 2011. Under this scheme, banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) from the RBI, at the interest rate 1 per cent (100 basis points) higher than the current repo rate. In an attempt to strengthen rupee and checking its falling exchange rate, the RBI increased the gap between ‘repo’ and MSF to 3 per cent (late July 2013). The MSF rate has been floated as a penal rate and since mid-2015 RBI has maintained it 1 per cent higher than the prevailing repo rate. By end March 2020 it is at 4.65 per cent, fully aligned with the Bank rate (i.e., equal to the Bank rate).  

Other Tools 

Other than the above-given instruments, RBI uses some other important, too to activate the right kind of the credit and monetary policy—

(i) Call Money Market: The call money market is an important segment of the money market where borrowing and lending of funds take place on over night basis. Participants in the call money market in India currently include scheduled commercial banks (SCBs) —excluding regional rural banks), cooperative banks (other than land development banks), insurance. Prudential limits, in respect of both outstanding borrowing and lending transactions in the call money market for each of these entities, are specified by the RBI.
In recent times, several changes have been introduced by the RBI in this market. By April 2016, banks were allowed to borrow only 1 per cent of their NDTL (net demand and time liabilities, i.e., total deposit of the banks, in layman term) under overnight facility at repo rate. For the rest of 0.75 per cent of their NDTL, they may use the term repos of different tenors. In a sense, since late 2013, RBI has been discouraging banks to use repo route and switch over to term repos for their requirements of the short-term funds. Promoting stability and signalling better cost of loans are the main objectives of 18 19this changed stance.
(ii) Open Market Operations (OMOs): OMOs are conducted by the RBI via the sale/purchase of government securities (G-Sec) to/from the market with the primary aim of modulating rupee liquidity conditions in the market. OMOs are an effective quantitative policy tool in the armoury of the RBI, but are constrained by the stock of government securities available with it at a point in time. Other than the institutions, now individuals will also be able to participate in this market (the decision was taken in 2017 while it is yet to be implemented).
(iii) Liquidity Adjustment Facility (LAF): The LAF is the key element in the monetary policy operating framework of the RBI (introduced in June 2000). On daily basis, the RBI stands ready to lend to or borrow money from the banking system, as per the need of the time, at fixed interest rates (repo and reverse repo rates). Together with moderating the fund-mismatches of the banks, LAF operations help the RBI to effectively transmit interest rate signals to the market. The recent changes regarding a cap on the repo borrowing and provision of the term repo have changed the very dynamics of this facility after 2013.
(iv) Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank. The instrument thus has features of both, SLR and CRR.
(v) Standing Deposit Facility Scheme (SDFS): The new scheme has been proposed by the Union Budget 2018–19. Such a tool was proposed by the RBI in November 2015 itself. The scheme is aimed at helping RBI to manage liquidity in a better way, especially when the economy is flush with excess fund (as was seen after the demonetisation of the high value currency notes post- November 2016).