eefect of monitry policy on banking sectror

1. A
PROJECT REPORT
ON
“EFFECT OF MONETARY POLICY ON BANKING SECTOR”
IN RESPECT OF PUNJAB STATE COOPERATIVE BANK
BATHINDA.
Submitted In the partial fulfillment of the requirement
for the award of the degree of BACHELOR OF
BUSINESS ADMINISTRATION (Finance).
Submitted to: Submitted by:
Punjabi University, Patiala Shweta Tandon
B.B.A (Part3rd
)
Roll no. 10837
Under the guidance of
Ms. Vijay laxmi
(Asst. Professor in Management)
S.S.D WOMEN’S INSTITUTE OF TECHNOLOGY, BATHINDA
(Affiliated to Punjabi university, Patiala)
1

2. 2

3. CERTIFICATE
This is certified that Project entitled ‘Effect of monetary policy on banking sector in Punjab state
cooperative bank’ submitted by Miss Shweta Tandon conducted a boundary bonaified piece of work
under my direct supervision and guidance. No part of this has been submitted for any other university. It
may be considered for evaluation of partial fulfillment of the requirement for award of ‘Bachelor of
Business Administration’.
Project Guide
Mrs. Vijay Laxmi
3

4. DECLARATION
This is to certify that Project Report on “Effect of monetary policy on banking sector
Punjab state cooperative bank” submitted by me in Bachelor of Business Administration
Program from S.S.D. WOMAN’S INSTITUTE OF TECHNOLOGY, BATHINDA
(Punjabi University, Patiala) is my original work and the project report has not formed the
basis for award of any diploma, degree, associate ship, fellowship or similar other titles. It
embodies the original work done by under the able guidance supervision of Ms. Vijay
Laxmi (GUIDE & FACULTY) S.S.D WOMEN’S INSTITUTE OF TECHNILOGY.
----------------------------------
Shweta
B.B.A 6th
Semester
4

5. ACKNOWLEDGEMENT
Preparing a project is never unilateral effort I wish to acknowledge the guidance of the
professionals in bringing up the real picture of project is prepared.
I indebt to Sh. Gurdip Singh Sidhu for their insightful annotations and assistance thought the
project. Their unfailing enthusiasm and guidance kept me motivated and encourage in project.
I also express our thanking to all the staff members of the will whose names I unable to mention
here for their kind cooperation and valuable guidance to complete our project.
I also express my special thanks to Mrs. Vijay Laxmi .
Shweta Tandon
5

6. CONTENTS
CHAPTERS
 NATURE AND
SCOPE OF
BANKING
CTIVITIES
 PARAMETERS
OF MP
3- MONETARY POLICY IN INDIA
4- FUNCTIONS OF COOPERATIVE BANK
5-RESEARCH METHODOLOGY
- TYPES OF RESEARCH
- DATA COLLECTIN METHOD
-OBJECTIVES OF STUDY
-
IMPACT OF
MONETARY
7-SUGGETIONS
8-BIBLOGRAPHY
1- INTRODUCTION TO BANK
 MEANING OF
BANKING
 FUNCTIONS OF
BANK
2- MONETARY POLICY
 MEANING OF
MP
 OBJECTIVES OF
MP
 INSTRUMENTS
OF MP
6- EFFECT OF MONETARY POLICY ON BANKS
- INTREST RATES
6

7. CHAPTER-1
INTRODUCTION
TO
BANK
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8. Meaning of the terms Bank and Banking
Bank is an institution which deals in money and credit. It Accepts deposits from the public and grants
loans and advances to those who are in need of funds for various purposes. Banking is an activity which
involves acceptance of deposits for the purpose of lending or investing. In addition to accepting deposits
and lending funds, banking also involves providing various other services along with its main banking
activity. These are mainly agency services, but include several general services as well. A banker is one
who undertakes banking activities, accepting deposits and lending money for different purposes. The
Banking Regulation Act, 1949 defines banking as an activity of accepting funds from the public for the
purpose of lending or investment.
The essential features of banking activities are as follows:-
i) Accepting deposits from public;
ii) Lending or investment of such deposits;
iii) Incidental to the activities of accepting deposits for lending or investing, banks undertake activities
like —
a) Promoting and mobilizing savings of the public;
b) Providing funds to trade and industry by way of discounting bills, overdraft, cash credit facility, and
transfer of funds from one place to another;
c) Providing agency services to customers, such as collection Of bills, payment of insurance premium,
purchase and sale Of securities, etc., and other general services, such as issue of travelers’ cheques, credit
cards, locker facility, etc; Money deposited with the bank is assured as far as its Safety is concerned.
Further the depositor is allowed to withdraw it whenever required. Banks allow interest on deposits. Such
interest helps in the growth of funds deposited with the bank. Thus the rate of interest provided on
deposits acts as an incentive to the depositors.
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9. Reserve Bank of India (Central Bank)
In every country, the bank which is entrusted with the responsibility of guiding and regulating the
banking system is known as the Central Bank. In India the central banking authority is the Reserve Bank
of India. The Reserve Bank does not deal directly with the members of public. It acts as bankers’ bank
maintaining deposit accounts of all other banks and advances money to banks whenever needed. It
regulates the volume of currency and credit, and has powers of control and supervision over all banking
institutions. The Reserve Bank also acts as government banker and maintains the record of goverment
receipts, payments and borrowings under various heads. It advises the government on monetary and
credit policy, besides deciding on the rate of interest on bank deposits and bank loans. It is the custodian
of currency reserves consisting of foreign exchange, gold and other securities. Another important
function of the Reserve Bank is the issue of currency notes and regulation of the money supply.
9

10. Co-operative Banks/Society
Co-operative Banks in India are established under the provisions of the Co-operative Societies Act 1912.
These are organized on co-operative basis. It was with a view to provide adequate credit at economical
rates of interest to the farmers, that co-operative credit societies were first organized in villages for
providing financial help to agriculturist and rural artisans.
Co-operatives banks are organized both at primary and district level. Co-operative Credit Societies
(banks) at the primary level/local level are members of central co-operative banks at the district level.
Similarly, at the state level, there are state co-operative bank, which finance, co-ordinate and control the
central co-operative banks in each state. Thus the structure of co-operative banks in India is pyramidal in
nature.
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11. A co-operative credit society (bank) at the primary level can be formed by the local people
having common interest and common purposes. The co-operative banks generally grant loans for
productive purposes but they can also do so for other purposes. The rate of interest charged is very
moderate. The mode of recovery of loan is not very rigid.
The Reserve Bank of India was founded on 1 April 1935 to respond to economic troubles after the First
World War, The Bank was set up based on the recommendations of the 1926 Royal Commission on
Indian Currency and Finance, also known as the Hilton–Young Commission. The original choice for the
seal of RBI was The East India Company Double Mohur, with the sketch of the Lion and Palm Tree.
However it was decided to replace the lion with the tiger, the national animal of India. The Preamble of
the RBI describes its basic functions to regulate the issue of bank notes, keep reserves to secure monetary
stability in India, and generally to operate the currency and credit system in the best interests of the
country. The Central Office of the RBI was initially established in Calcutta (now Kolkata), but was
permanently moved to Bombay (now Mumbai) in 1937. The RBI also acted as Burma's central bank,
except during the years of the Japanese occupation of Burma (1942–45), until April 1947, even though
Burma seceded from the Indian Union in 1937. After the Partition of India in 1947, the Bank served as
the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations.
Though originally set up as a shareholders’ bank, the RBI has been fully owned by the Government of
India since its nationalization in 1949.
1950–1960
In the 1950s, the Indian government, under its first Prime Minister Jawaharlal Nehru, developed a
centrally planned economic policy that focused on the agricultural sector. The administration
nationalized commercial banks and established, based on the Banking Companies Act of 1949 (later
called the Banking Regulation Act), a central bank regulation as part of the RBI. Furthermore, the central
bank was ordered to support the economic plan with loans.[7]
1960–1969
As a result of bank crashes, the RBI was requested to establish and monitor a deposit insurance system. It
should restore the trust in the national bank system and was initialized on 7 December 1961. The Indian
government founded funds to promote the economy and used the slogan Developing Banking. The
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12. Government of India restructured the national bank market and nationalized a lot of institutes. As a
result, the RBI had to play the central part of control and support of this public banking sector.
1969–1985
In 1969, the Indira Gandhi-headed government nationalized 14 major commercial banks. Upon Gandhi's
return to power in 1980, a further six banks were nationalized. The regulation of the economy and
especially the financial sector was reinforced by the Government of India in the 1970s and 1980s The
central bank became the central player and increased its policies for a lot of tasks like interests, reserve
ratio and visible deposits. These measures aimed at better economic development and had a huge effect
on the company policy of the institutes. The banks lent money in selected sectors, like agri-business and
small trade companies.
The branch was forced to establish two new offices in the country for every newly established office in a
town. The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to
reduce the effects.
1985–1991
A lot of committees analyzed the Indian economy between 1985 and 1991. Their results had an effect on
the RBI. The Board for Industrial and Financial Reconstruction, the Indira Gandhi Institute of
Development Research and the Security & Exchange Board of India investigated the national economy
as a whole, and the security and exchange board proposed better methods for more effective markets and
the protection of investor interests. The Indian financial market was a leading example for so-called
"financial repression" (Mackinnon and Shaw).[13]
The Discount and Finance House of India began its
operations on the monetary market in April 1988; the National Housing Bank, founded in July 1988, was
forced to invest in the property market and a new financial law improved the versatility of direct deposit
by more security measures and liberalization.
1991–2000
The national economy came down in July 1991 and the Indian rupee was devalued The currency lost
18% relative to the US dollar, and the Narsimahmam Committee advised restructuring the financial
sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were
published in 1993 to establish a private banking sector. This turning point should reinforce the market
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13. and was often called neo-liberal. The central bank deregulated bank interests and some sectors of the
financial market like the trust and property markets. This first phase was a success and the central
government forced a diversity liberalization to diversify owner structures in 1998.
The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalized
banks in July to interact with the capital market to reinforce their capital base. The central bank founded
a subsidiary company—the Bharatiya Reserve Bank Note Mudran Limited—in February 1995 to
produce banknotes.
Since 2000
The Foreign Exchange Management Act from 1999 came into force in June 2000. It should improve the
foreign exchange market, international investments in India and transactions. The RBI promoted the
development of the financial market in the last years, allowed online banking in 2001 and established a
new payment system in 2004–2005 (National Electronic Fund Transfer). The Security Printing &
Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces
banknotes and coins.
The national economy's growth rate came down to 5.8% in the last quarter of 2008–2009 and the central
bank promotes the economic development
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14. Nature and Scope of Cooperative Banking
Banking activities are considered to be the life blood of the national economy. Without banking services,
trading and business activities cannot be carried on smoothly. Banks are the distributors and protectors of
liquid capital which is of vital significance to a developing country. Efficient administration of the
banking system helps in the economic growth of the nation. Banking is useful to trade and commerce.
Banking activities are useful to trade and industry in the following ways.
a) Money deposited in a bank remains safe. Precious articles too can be kept in the safe custody of banks
in lockers.
b) Banks provide credit facilities to their customers. Customers with bank accounts also enjoy better
credit in the business world.
c) Banks encourage the habit of saving and thrift among people. They mobilize savings and invest them
in productive activities. Thus, they help in increasing the rate of savings and investment
in the country.
d) Banks provide a convenient and safe means of transferring money from one place to another and
facilitate business dealings/ transactions.
e) Banks collect and realize bills, cheque, interest and dividend warrants etc. on behalf of their
customers.
f) Foreign trade is facilitated considerably with the help of banks which receive and make payments,
provide credit and deal in foreign exchange. They protect importers from the risk of loss on account of
exchange rate fluctuations. They issue letter of credit and provide information on the credit worthiness of
importers. They also act as referees of their customers.
g) Banks meet the financial needs of small-scale business units
Which are located in economically backward areas.
h) Farmers and artisans in rural areas can also avail of bank credit for financing their activities.
i) Commercial banks provide many other services to the general public which includes locker facility,
issue of traveler’s cheque and gift cheque, payment of insurance premium, etc.
14

15. Effect of suspension of banking activities on Trade
Commerce and Industry
As a result of economic growth, increase in money supply, growth of banking habits, and control and
guidance by Reserve Bank of India, the Indian banking system has achieved a record progress over the
years. Banking activities in our economy have become so imperative and important for the trading
community and even for the general public, that even a temporary halt in banking activities may vitally
affect trade, commerce and industry. This position can be explained
briefly as follows.
(i) In the event of suspension of banking activities, people would neither be able to deposit their savings
in banks, nor be able to withdraw money from banks. Savings are then likely to decline with a
corresponding increase in consumption expenditure.
(ii) Non-availability of bank loans and credit facilities will adversely affect industrial production. The
volume of trade will shrink. Limited cash in hand and inadequate currency in circulation may not permit
cash transactions in buying and selling of all goods. With reduced production and rising consumption
expenditure prices would tend to rise. Traders may exploit the situation by hoarding and black-marketing
of essential goods.
(iii) Farmers and small business units will suffer badly if banking operations are suspended. They will be
forced to go to money lenders to borrow money at high rates of interest when bank finance is not
available.
(iv) Foreign trade will be badly affected in the absence of facilities regarding issue of letter of credit and
foreign exchange transactions.
(v) Business firms as well as the public will have to depend on postal services and private agencies for
remittance of money and on other agencies for collection of bills, interest and dividend warrants. Heavy
expenses will have to be incurred for the services.
(vi) People will have to go to courts of law for recovery of their jewellery and other valuable articles
from bank lockers. We cannot think of any day without the use of banking services such is the
importance of banking in our daily life.
15

16. CHAPTER-2
MONETARY POLICY
16

17. Monetary policy
Introduction:-
Monetary policy is the process by which the monetary authority of a country controls the supply of
money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The
official goals usually include relatively stable prices and low unemployment. Monetary theory provides
insight into how to craft optimal monetary policy. It is referred to as either being expansionary or
concretionary, where an expansionary policy increases the total supply of money in the economy more
rapidly than usual, and contraction policy expands the money supply more slowly than usual or even
shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by
lowering interest rates in the hope that easy credit will entice businesses into expanding. Concretionary
policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of
asset values. Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money
or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.
Monetary theory provides insight into how to craft optimal monetary policy.
Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at
which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to
control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with
other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is
a regulated system of issuing currency through banks which are tied to a central bank, the monetary
authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy
goals).
The term monetary policy is also known as the 'credit policy' or called 'RBI's money
management policy' in India. How much should be the supply of money in the economy? How much
should be the ratio of interest? How much should be the viability of money? etc. Such questions are
considered in the monetary policy. From the name itself it is understood that it is related to the demand
and the supply of money.
17

18. VARIOUS DEFINITIONS;-
Economic strategy chosen by a government in deciding expansion or contraction in the country's
money-supply. Applied usually through the central bank, a monetary policy employs three major tools:
(1) Buying or selling national debt
(2) Changing credit restrictions
(3) Changing the interest rates by changing reserve requirements.
Monetary policy plays the dominant role in control of the aggregate-demand and, by
extension, of inflation in an economy. Also called monetary regime.
According to Prof. Harry Johnson,
"A policy employing the central banks control of the supply of money as an instrument for achieving the
objectives of general economic policy is a monetary policy."
According to A.G. Hart,
"A policy which influences the public stock of money substitute of public demand for such assets of both
that is policy which influences public liquidity position is known as a monetary policy."
From both these definitions, it is clear that a monetary policy is related to the availability and cost of
money supply in the economy in order to attain certain broad objectives. The Central Bank of a nation
keeps control on the supply of money to attain the objectives of its monetary policy.
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19. Objectives of Monetary Policy
The objectives of a monetary policy in India are similar to the objectives of its five year plans. In a
nutshell planning in India aims at growth, stability and social justice. After the Keynesian revolution in
economics, many people accepted significance of monetary policy in attaining following objectives.
1. Rapid Economic Growth
2. Price Stability
3. Exchange Rate Stability
4. Balance of Payments (BOP) Equilibrium
5. Full Employment
6. Neutrality of Money
7. Equal Income Distribution
These are the general objectives which every central bank of a nation tries to attain by employing certain
tools (Instruments) of a monetary policy. In India, the RBI has always aimed at the controlled expansion
of bank credit and money supply, with special attention to the seasonal needs of a credit.Let us now see
objectives of monetary policy in detail:-
1. Rapid Economic Growth: It is the most important objective of a monetary policy. The
monetary policy can influence economic growth by controlling real interest rate and its resultant
impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates,
the investment level in the economy can be encouraged. This increased investment can speed up
economic growth. Faster economic growth is possible if the monetary policy succeeds in maintaining
income and price stability.
2. Price Stability: All the economics suffer from inflation and deflation. It can also be called as
Price Instability. Both inflation are harmful to the economy. Thus, the monetary policy having an
objective of price stability tries to keep the value of money stable. It helps in reducing the income and
wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy
money policy' but when there is inflationary situation there should be a 'dear money policy'.
3. Exchange Rate Stability: Exchange rate is the price of a home currency expressed in terms
of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the
19

20. exchange rate, the international community might lose confidence in our economy. The monetary
policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign
exchange reserves tries to influence the demand for foreign exchange and tries to maintain the
exchange rate stability.
4. Balance of Payments (BOP) Equilibrium: Many developing countries like India suffer
from the Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to
maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and
the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the
later stands for stringency of money. If the monetary policy succeeds in maintaining monetary
equilibrium, then the BOP equilibrium can be achieved.
5. Full Employment: The concept of full employment was much discussed after Keynes's
publication of the "General Theory" in 1936. It refers to absence of involuntary unemployment. In
simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs.
However it does not mean that there is Zero unemployment. In that senses the full employment is
never full. Monetary policy can be used for achieving full employment. If the monetary policy is
expansionary then credit supply can be encouraged. It could help in creating more jobs in different
sector of the economy.
6. Neutrality of Money: Economist such as Wicks Ted, Robertson has always considered
money as a passive factor. According to them, money should play only a role of medium of exchange
and not more than that. Therefore, the monetary policy should regulate the supply of money. The
change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the
supply of money and neutralize the effect of money expansion. However this objective of a monetary
policy is always criticized on the ground that if money supply is kept constant then it would be
difficult to attain price stability.
7. Equal Income Distribution: Many economists used to justify the role of the fiscal policy is
maintaining economic equality. However in resent years economists have given the opinion that the
monetary policy can help and play a supplementary role in attainting an economic equality. Monetary
policy can make special provisions for the neglect supply such as agriculture, small-scale industries,
village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for
these sectors to come up. Thus in recent period, monetary policy can help in reducing economic
inequalities among different sections of society
20

21. Instrument of monetary policy
The instruments of monetary policy are tools or devise which are used by the monetary authority in order
to attain some predetermined objectives. There are two types of instruments of the monetary policy as
shown below.
(A) Quantitative Instruments or General Tools
The Quantitative Instruments are also known as the General Tools of monetary policy. These tools are
related to the Quantity or Volume of the money. The Quantitative Tools of credit control are also called
as General Tools for credit control. They are designed to regulate or control the total volume of bank
credit in the economy. These tools are indirect in nature and are employed for influencing the quantity of
credit in the country. The general tool of credit control comprises of following instruments.
1. Bank Rate Policy (BRP)
The Bank Rate Policy (BRP) is a very important technique used in the monetary policy for influencing
the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central
bank (i.e. RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial
banks against approved securities. It is "the standard rate at which the bank is prepared to buy or
rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act". The
Bank Rate affects the actual availability and the cost of the credit. Any change in the bank rate
necessarily brings out a resultant change in the cost of credit available to commercial banks. If the RBI
increases the bank rate than it reduce the volume of commercial banks borrowing from the RBI. It deters
banks from further credit expansion as it becomes a more costly affair. Even with increased bank rate the
actual interest rates for a short term lending go up checking the credit expansion. On the other hand, if
the RBI reduces the bank rate, borrowing for commercial banks will be easy and cheaper. This will boost
the credit creation. Thus any change in the bank rate is normally associated with the resulting changes in
the lending rate and in the market rate of interest. However, the efficiency of the bank rate as a tool of
monetary policy depends on existing banking network, interest elasticity of investment demand, size and
strength of the money market, international flow of funds, etc.
21

22. 2. Open Market Operation (OMO)
The open market operation refers to the purchase and/or sale of short term and long term securities by the
RBI in the open market. This is very effective and popular instrument of the monetary policy. The OMO
is used to wipe out shortage of money in the money market, to influence the term and structure of the
interest rate and to stabilize the market for government securities, etc. It is important to understand the
working of the OMO. If the RBI sells securities in an open market, commercial banks and private
individuals buy it. This reduces the existing money supply as money gets transferred from commercial
banks to the RBI. Contrary to this when the RBI buys the securities from commercial banks in the open
market, commercial banks sell it and get back the money they had invested in them. Obviously the stock
of money in the economy increases. This way when the RBI enters in the OMO transactions, the actual
stock of money gets changed. Normally during the inflation period in order to reduce the purchasing
power, the RBI sells securities and during the recession or depression phase she buys securities and
makes more money available in the economy through the banking system. Thus under OMO there is
continuous buying and selling of securities taking place leading to changes in the availability of credit in
an economy.
However there are certain limitations that affect OMO viz; underdeveloped securities market, excess
reserves with commercial banks, indebtedness of commercial banks, etc.
3. Variation in the Reserve Ratios (VRR)
The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash
Reserves. Some part of these cash reserves are their total assets in the form of cash. Apart of these cash
reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in
an economy. These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity
Ratio (SLR). The CRR refers to some percentage of commercial bank's net demand and time liabilities
which commercial banks have to maintain with the central bank and SLR refers to some percent of
reserves to be maintained in the form of gold or foreign securities. In India the CRR by law remains in
between 3-15 percent while the SLR remains in between 25-40 percent of bank reserves. Any change in
the VRR (i.e. CRR + SLR) brings out a change in commercial banks reserves positions. Thus by varying
VRR commercial banks lending capacity can be affected. Changes in the VRR helps in bringing changes
in the cash reserves of commercial banks and thus it can affect the banks credit creation multiplier. RBI
22

23. increases VRR during the inflation to reduce the purchasing power and credit creation. But during the
recession or depression it lowers the VRR making more cash reserves available for credit expansion.
(B) Qualitative Instruments or Selective Tools
The Qualitative Instruments are also known as the Selective Tools of monetary policy. These tools are
not directed towards the quality of credit or the use of the credit. They are used for discriminating
between different uses of credit. It can be discrimination favoring export over import or essential over
non-essential credit supply. This method can have influence over the lender and borrower of the credit.
The Selective Tools of credit control comprises of following instruments.
1. Fixed Margin Requirements
The margin refers to the "proportion of the loan amount which is not financed by the bank". Or in other
words, it is that part of a loan which a borrower has to raise in order to get finance for his purpose. A
change in a margin implies a change in the loan size. This method is used to encourage credit supply for
the needy sector and discourage it for other non-necessary sectors. This can be done by increasing
margin for the non-necessary sectors and by reducing it for other needy sectors. Example:- If the RBI
feels that more credit supply should be allocated to agriculture sector, then it will reduce the margin and
even 85-90 percent loan can be given.
2. Consumer Credit Regulation
Under this method, consumer credit supply is regulated through hire-purchase and installment sale of
consumer goods. Under this method the down payment, installment amount, loan duration, etc is fixed in
advance. This can help in checking the credit use and then inflation in a country.
3. Publicity
This is yet another method of selective credit control. Through it Central Bank (RBI) publishes various
reports stating what is good and what is bad in the system. This published information can help
commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly
bulletins, the information is made public and banks can use it for attaining goals of monetary policy.
23

24. 4. Credit Rationing
Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for
each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of
credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit
expoursure to unwanted sectors.
5. Moral Suasion
It implies to pressure exerted by the RBI on the Indian banking system without any strict action for
compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary
periods. Commercial banks are informed about the expectations of the central bank through a monetary
policy. Under moral suasion central banks can issue directives, guidelines and suggestions for
commercial banks regarding reducing credit supply for speculative purposes.
6. Control through Directives
Under this method the central bank issue frequent directives to commercial banks. These directives guide
commercial banks in framing their lending policy. Through a directive the central bank can influence
credit structures, supply of credit to certain limit for a specific purpose. The RBI issues directives to
commercial banks for not lending loans to speculative sector such as securities, etc beyond a certain
limit.
7. Direct Action
Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the
RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse
credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a
bank by changing some rates. At last it can even put a ban on a particular bank if it dose not follow its
directives and work against the objectives of the monetary policy.
24

25. Parameters of Monetary Policy in India
Objectives
It is generally believed that central banks ideally should have a single overwhelming objective of
price stability. In practice, however, central banks are responsible for a number of objectives besides
price stability, such as currency stability, financial stability, growth in employment and income. The
primary objectives of central banks in many cases are legally and institutionally defined. However, all
objectives may not have been spelt out explicitly in the central bank legislation but may evolve through
traditions and tacit understanding between the government, the central bank and other major institutions
in an economy.
Of late, however, considerations of financial stability have assumed increasing importance in
monetary policy. The most serious economic downturns in the recent years appear to be generally
associated with financial instability. The important questions for policy in the context of financial
instability are the origin and the transmission of different types of shocks in the financial system, the
nature and the extent of feedback in policy and the effectiveness of different policy instruments.
Transmission Mechanism
Monetary policy is known to have both short and long-term effects. While it generally affects the
real sector with long and variable lags, monetary policy actions on financial markets, on the other hand,
usually have important short-run implications. Typical lags after which monetary policy decisions begin
to affect the real sector could vary across countries. It is, therefore, essential to understand the
transmission mechanism of monetary policy actions on financial markets, prices and output. Central
banks form their own views on the transmission mechanism based on empirical evidence, and their
monetary strategies and tactics are designed, based on these views. However, there could be considerable
uncertainties in the transmission channels depending on the stages of evolution of financial markets and
the nature of propagation of shocks to the system.
The four monetary transmission channels, which are of concern to policy makers are: the
quantum channel, especially relating to money supply and credit; the interest rate channel; the exchange
rate channel, and the asset prices channel. Monetary policy impulses under the quantum channel affect
the real output and price level directly through changes in either reserve money, money stock or credit
aggregates. The remaining channels are essentially indirect as the policy impulses affect real activities
through changes in either interest rates or the exchange rate or asset prices. Since none of the channels of
25

26. monetary transmission operate in isolation, considerable feedbacks and interactions, need to be carefully
analyses for a proper understanding of the transmission mechanism.
The exact delineation of monetary policy transmission channels becomes difficult in the wake of
uncertainties prevalent in the economic system, both in the sense of responsiveness of economic agents
to monetary policy signals on the one hand, and the proper assessment by the monetary authority of the
quantum and extent of desired policy measures on the other. The matter is particularly complex in
developing countries where the transmission mechanism of monetary policy is in a constant process of
evolution due to significant ongoing structural transformation of the economy.
Strategies and Tactics
It is important to distinguish strategic and tactical considerations in the conduct of monetary policy.
While monetary strategy aims at achieving final objectives, tactical considerations reflect the short run
operational procedures. Both strategies and tactics for monetary management are intricately linked to the
overall monetary policy framework of a central bank. Depending upon the domestic and international
macroeconomic developments, the long run strategic objective could change, leading to a change in the
nature and the extent of short run liquidity management.
The strategic aspects of monetary management crucially depend on the choice of a nominal anchor
by the central bank. In this regard, four broad classes of monetary strategies could be distinguished. Two
of these, viz., monetary targeting and exchange rate targeting strategies, use a monetary aggregate and
the exchange rate respectively as an explicit intermediate target. The third, viz., multiple indicator
approach, does not have an explicit intermediate target but is based on a wide range of monetary and
financial indicators. The fourth, viz., inflation targeting, also does not have an intermediate target, but is
characterized by an explicit final policy goal in terms of the rate of inflation.
In the 1970s when monetary policy came into prominence, many countries adopted either money
supply or exchange rate as intermediate targets. During the late 1980s, these paradigms started to change
following globalization, technological advancements and large movement of capital across national
boundaries.
In view of difficulties in conducting monetary policy with explicit intermediate targets, of late,
some countries are switching to direct inflation targeting, which works by explicitly announcing to the
public the goals for monetary policy and the underlying framework for its implementation.
26

27. In this framework, the monetary authorities have the freedom to deploy the instruments of
monetary policy to the best of their capacities, but are limited in their discretion of policy goals. The
framework is advocated on the ground that it clearly spells out the extent of central bank accountability
and transparency.
In reality, monetary policy strategy of a central bank depends on a number of factors that are
unique to the country and the context. Given the policy objective, any good strategy depends on the
macroeconomic and the institutional structure of the economy. An important factor in this context is the
degree of openness of the economy. The more open an economy is, the more the external sector plays a
dominant role in monetary management. The second factor that plays a major role is the stage of
development of markets and institutions: with technological development as an essential ingredient. In a
developed economy, the markets are integrated and policy actions are quickly transmitted from one
sector to another. In such a situation, perhaps it is possible for the central bank to signal its intention with
one single instrument.
Operating Procedures
Operating procedures refer to the choice of the operational target, the nature, extent and the
frequency of different money market operations, the use and width of a corridor for market interest rates
and the manner of signaling policy intentions. The choice of the operating target is crucial as this
variable is at the beginning of the monetary transmission process. The operating target of a central bank
could be bank reserves, base money or a benchmark interest rate. While actions of a central bank could
influence all these variables, it should be evident that the final outcome is determined by the combined
actions of the market forces and the central bank.The major challenge in day-to-day monetary
management is decision on an appropriate level of the operating target. The success in this direction
could be achieved only if the nature and the extent of interaction of the policy instruments with the
operating target is stable and is known to the central bank. As the operating target is also influenced by
market movements, which on occasions could be extremely volatile and unpredictable, success is not
always guaranteed. Further, success is also dependent on the stability of the relationship between the
operating target and the intermediate target. In a monetary targeting framework, this often boils down to
the stability and the predictability of the money multiplier. In an interest rate targeting framework, on the
other hand, success depends upon the strength of the relationship between the short-term and the long-
term interest rates. Finally, the stability of the relationship between the intermediate and the final target is
critical to the successful conduct of the operations.
27

28. Monetary Policy Transparency
Transparency in monetary policy is emphasized in the recent years on the ground that it leads to a
reduction in the market’s uncertainty about the monetary authority’s reaction function. It is further
argued that greater transparency may improve financial market’s understanding of the conduct of
monetary policy and thus reduce uncertainty. The limits to transparency are also recognized since
publishing detailed results of a central bank’s economic projections may eliminate an element of
surprise, which is useful on occasions with respect to the central bank’s operations in financial markets.
28

29. CHAPTER-3
MONETARY POLICY IN INDIA
29

30. Monetary Policy in India
Policy Making Process
Traditionally, the process of monetary policy in India had been largely internal with only the end
product of actions being made public. A process of openness was initiated by Governor Rangarajan and
has been widened, deepened and intensified by Governor Jalan. The process has become relatively more
articulate, consultative and participative with external orientation, while the internal work processes have
also been re-engineered to focus on technical analysis, coordination, horizontal management, rapid
responses and being market savvy.
The stance of monetary policy and the rationale are communicated to the public in a variety of
ways, the most important being the annual monetary policy statement of Governor Jalan in April and the
mid-term review in October. The statements have become over time more analytical, at times
introspective and a lot more elaborate. Further, the statements include not only monetary policy stance or
measures but also institutional and structural aspects. The monetary measures are undertaken as and
when the circumstances warrant, but the rationale for such measures is given in the Press Release and
also statements made by Governor and Deputy Governors unless a deliberate decision is taken not to do
so on a contemporaneous basis. The sources for appreciating the policy stance encompass several
statutory and non-statutory publications, speeches and press releases. Of late, the RBI website has
become a very effective medium of communication and it is rated by experts as one of the best among
central bank websites in content, presentation and timeliness. The Reserve Bank’s communications
strategy and provision of information have facilitated conduct of policy in an increasingly market-
oriented environment.
Several new institutional arrangements and work processes have been put in place to meet the
needs of policy making in a complex and fast changing world. At the apex of policy process is Governor,
assisted closely by Deputy Governors and guided by deliberations of a Board of Directors. A Committee
of the Board meets every week to review the monetary, economic, financial conditions and advise or
decide appropriately. Much of the data used by the Committee is available to the public with about a
week’s lag. There are several other standing committees or groups of the Board and Board for Financial
Supervision plays a critical role in regard to institutional developments. Periodic consultations with
academics, market participants and financial intermediaries take place through Standing Committees and
Groups, in addition to mechanisms such as resource management discussions with banks. Within the
30

31. Reserve Bank, the supervisory data, market information, economic and statistical analysis are reoriented
to suit the changing needs. A Financial Markets Committee focuses on a day-to-day market operations
and tactics while a Monetary Policy Strategy Group analyses strategies on an ongoing basis.
Operating Procedures
In the pre-reform period prior to 1991, given the command and control nature of the economy, the
Reserve Bank had to resort to direct instruments like interest rate regulations, selective credit control and
the cash reserve ratio (CRR) as major monetary instruments. These instruments were used intermittently
to neutralise the monetary impact of the Government’s budgetary operations.
The administered interest rate regime during the earlier period kept the yield rate of the
government securities artificially low. The demand for them was created through intermittent hikes in the
Statutory Liquidity Ratio (SLR). The task before the Reserve Bank was, therefore, to develop the
markets to prepare the ground for indirect operations.
As a first step, yields on government securities were made market related. At the same time, the
Reserve Bank helped create an array of other market related financial products. At the next stage, the
interest rate structure was simultaneously rationalized and banks were given the freedom to determine
their major rates. As a result of these developments, the Reserve Bank could use OMO as an effective
instrument for liquidity management including to curb short-term volatilities in the foreign exchange
market.
Another important and significant change introduced during the period is the reactivation of the
Bank Rate by initially linking it to all other rates including the Reserve Bank’s refinance rates (April
1997). The subsequent introduction of fixed rate repo (December 1997) helped in creating an informal
corridor in the money market, with the repo rate as floor and the Bank Rate as the ceiling. The use of
these two instruments in conjunction with OMO enabled the Reserve Bank to keep the call rate within
this informal corridor for most of the time. Subsequently, the introduction of Liquidity Adjustment
Facility (LAF) from June 2000 enabled the modulation of liquidity conditions on a daily basis and also
short term interest rates through the LAF window, while signaling the stance of policy through changes
in the Bank Rate.
31

32. Gains from Reform
It has been possible to reduce the statutory preemption on the banking system. The Cash Reserve
Ratio, which was the primary instrument of monetary policy, has been brought down from 15.0 per cent
in March 1991 to 5.5 per cent by December 2001. The medium-term objective is to bring down the CRR
to its statutory minimum level of 3.0 per cent within a short period of time. Similarly, Statutory Liquidity
Ratio has been brought down from 38.5 per cent to its statutory minimum of 25.0 per cent by October
1997.
It has also been possible to deregulate and rationalize the interest rate structure. Except savings
deposit, all other interest rate restrictions have been done away with and banks have been given full
operational flexibility in determining their deposit and lending rates barring some restrictions on export
credit and small borrowings.
The commercial lending rates for prime borrowers of banks have fallen from a high of about 16.5
per cent in March 1991 to around 10.0 per cent by December 2001.
In terms of monetary policy signals, while the Bank Rate was dormant and seldom used in 1991, it
has been made operationally effective from 1997 and continues to remain the principal signaling
instrument. The Bank Rate has been brought down from 12.0 per cent in April 1997 to 6.5 per cent by
December 2001. It is envisaged that the LAF rate would operate around the Bank Rate, with a flexible
corridor, as more active operative instrument for day-to-day liquidity management and steering short-
term interest rates.
A contrasting feature in the positions between 1991 and 2001 is India’s foreign exchange
reserves. The monetary and credit policy for 1991-92 was formulated against the background of a
difficult foreign exchange situation. Over the period, external debt has been contained and short-term
debt severely restricted, while reserves have been built in an atmosphere of liberalization of both current
account and to some extent capital account.
The foreign currency assets of the Reserve Bank have increased from US $ 5.8 billion in March
1991 to US $ 48.0 billion in December 2001. In view of comfortable foreign exchange reserves, periodic
oil price increases (for example in 1996-97, 1999-00 and 2000-01) did not translate into Balance of
Payment (BoP) crises as in the earlier occasions. Such enlargement of the foreign currency assets, on the
other hand, completely altered the balance sheet of the Reserve Bank.
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33. Large capital inflows have been accommodated by the Reserve Bank while its monetary impact
has been sterilised through OMO. This has helped in reducing the government’s reliance on credit from
the Reserve Bank. Consequently, there has been secular decline in monetized deficit, and in the process
net foreign exchange assets of the Reserve Bank have become the principal contributor to reserve money
expansion in the recent period.
Tasks before the Reserve Bank
These are impressive gains from reforms but there are emerging challenges to the conduct of
monetary policy in our country. Thus, while the twin objectives of monetary policy of maintaining price
stability and ensuring availability of adequate credit to the productive sectors of the economy have
remained unchanged, capital flows and liberalization of financial markets have increased the potential
risks of institutions, thus bringing the issue of financial stability to the fore. Credit flow to agriculture and
small- and medium-industry appears to be constrained causing concerns. There are significant structural
and procedural bottlenecks in the existing institutional set up for credit delivery. The pace of reforms in
real sector, particularly in property rights and agriculture also impinge on the flow of credit in a
deregulated environment. The persistence of fiscal deficit, with the combined deficit of the Central and
State Governments continuing to be high, draws attention to the delicate internal and external balance.
It is necessary to recognize the existence of the large informal sector, the limited reach of financial
markets relative to the growing sectors, especially services, and the overhang of institutional structure
that tend to constrain the effectiveness of monetary policy in India. The road ahead would be demanding
and the Reserve Bank would have to strive to meet the challenge of steering the structurally transforming
economy from a transitional phase to a mature and vibrant system and increasingly deal with alternative
phases of the business cycle. Some of the immediate tasks before the Reserve Bank are presented to
provoke debate and promote research.
Modeling Exercises
In addressing a gathering of elite econometricians assembled here, a mention should be made about
developments in monetary modeling. It is well recognized that monetary policy decisions must be based
on some idea of how decisions will affect the real world and this implies conduct of policy within the
framework of a model. As Dr. William White of Bank for International Settlements (BIS) mentioned in
an address recently in RBI, “the model may be as simple as one unspecified equation kept in the head of
the central bank Governor, but one must begin somewhere. Economics may not be a science, but it
33

34. should at least be conducted according to scientific principles recognizing cause and effect”. While
reliance on explicit modeling was rather heavy in some central banks, particularly in the 1960 and 1970s,
there has been increasing awareness among the policy makers of the limitations of such models for
several reasons. It is difficult to arrive at a proper model for any economy with the degree of certainty
that policy makers want especially in view of observed alterations in the private sector behavior in
response to official behavior.
Further, data to monitor the economy are sometimes inadequate, or delayed, and often revised. It is
said that in regard to modern economies, not only the future but even the past is uncertain, due to
significant revisions in data. The process of deregulation coupled with technological progress has led to
increasing role for market prices and consequently more complexities for establishing relationships in an
environment where everything happens very fast, and in a globally interrelated financial world. In brief,
there is need to recognize the complexities in model building for monetary policies and approach it with
great humility and a dose of skepticism but ample justification for such modeling work certainly persists.
It is felt that this is an appropriate time to explore more formally the relationship among different
segments of the markets and sectors of the economy, which will help in understanding the transmission
mechanism of the monetary policy in India. With this objective in mind, the Reserve Bank had already
announced its intention to build an operational model, which will help the policy decision process. An
Advisory Group with eminent academicians like Professors Mihir Rakshit, Dilip Nachane, Manohar Rao,
Vikas Chitre and Indira Rajaraman as external experts and a team from within the Reserve Bank were set
up for developing such a model.The model was initially conceived to focus on the short-term objective of
different sources and components of the reserve money based on the recommendations of an internal
technical group on Liquidity Analysis and Forecasting. Though multi-sector macro-econometric models
are available, such models are based on yearly data and hence these may not be very useful for guiding
the short-term monetary policy actions of the Reserve Bank.
Accordingly, it was felt that a short-term liquidity model may be developed in the Reserve Bank
focusing on the inter-linkages in the markets and then operational these linkages to other sectors of the
economy. The Advisory Group met twice and after deliberations felt that a daily/ weekly/fortnightly
model would give an idea about short- to medium-term movements but models using annual data will
also be useful to assess the implications of the monetary policy measures on the real economy. On the
basis of the advice of eminent experts in the Advisory Group, it has been decided to modify the
approach.
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35. The current thinking in the Reserve Bank is broadly on the following lines: the short-term liquidity
model making use of high frequency data will be explored. Accordingly, the interaction of the financial
markets with weekly data focusing mainly on policy measures and different rates in the financial
markets. An observation in the operational framework of the model is limited as the LAF has been
operationalised only a year ago. A crucial aspect in an exercise is the forecast of currency in circulation.
The intention of the Reserve Bank is to expedite the technical work in this regard and seek the
advice of individual members of Advisory Group on an ongoing basis both at formal and informal levels.
It is expected that the draft of the proposed model would be put in public domain shortly. The Reserve
Bank would seek the active participation of the interested econometricians in the debate on the draft
model and give benefit of advice to the Reserve Bank for finalizing and adoption.
Reduction in CRR
Among the unrealized medium-term objectives of reforms in monetary policy, the most important
is reduction in the prescribed CRR for banks to its statutory minimum of 3.0 per cent. The movement to
3.0 per cent can be designed in three possible ways, viz., the traditional way of pre-announcing a time-
table for reduction in the CRR; reducing CRR as and when opportunities arise as is being done in recent
years; and as a one-time reduction from the existing level to 3.0 per cent under a package of measures.
In the initial years, the first approach was effective but had to be abandoned when the time-table
had to be disrupted to meet the eruption of global financial uncertainties and pressures on foresaw
market. Hence, the second approach of lowering CRR when opportunities arise has been adopted, and
now it has been brought down to 5.5 per cent. However, if it is felt that this approach takes a longer time
and a compressed time-frame is desirable to expedite development of financial markets, it is possible to
contemplate a package of measures in this regard. The package could mean the reduction of CRR to the
statutory minimum level of 3.0 per cent accompanied by several changes such as in the present way of
maintenance of cash balances by banks with RBI. With the lagged reserve maintenance system now put
in place, banks can exactly know their reserve requirements. With the information technology available
with banks and with the operationalisation of Clearing Corporation of India Ltd. (CCIL) shortly and with
the development of repo market, it would be appropriate if CRR is maintained on a daily basis. However,
till banks adjust to such changes in the maintenance of CRR, a minimum balance of 95 per cent of the
required reserves on a daily basis may have to be maintained when CRR is reduced to 3.0 per cent. The
other elements of package have to be worked out carefully.
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36. Access to Call Money Market
An important related component of ongoing reform relates to restricting the call money market to
banks and Primary Dealers (PDs). Several measures have been initiated in this regard but in view of the
growing importance attached to stability in the financial system and the growing alternatives to access
liquidity management through activation of facilitated by the CCIL, there is a strong case to impose some
limits on access to non-collateralised borrowing through call money even under the dispensation of
restricted participation only to banks and PDs. The call money window should be used to iron out
temporary mismatches in liquidity and banks should not use this on a sustained basis as a source of
funding their normal requirements. A beginning has been made by prescribing for access to call money a
ceiling of 2.0 per cent of aggregate deposits in respect of urban cooperative banks (UCBs). Such a
stipulation can be extended to all commercial banks and with some modifications such as, an alternative
of 25.0 to 50.0 per cent of their net owned funds. If a bank has any temporary need to go beyond the
ceilings prescribed for access to call money, the Reserve Bank could consider such requests to alleviate
possible shocks to individual banks.
Similarly, once the repo market develops, PDs should reduce and in fact consider eliminating their
access to the call money market. There is an opinion that such restrictions of access to call money in
Indian conditions would add to stability in financial markets and help develop term money market. A
final decision would no doubt be taken after discussions in Technical Advisory Committee on financial
markets of the Reserve Bank, and further consultations with market participants.
Liquidity Adjustment Facility
The Reserve Bank influences liquidity on a day-to-day basis through LAF and is using this facility
as an effective flexible instrument for smoothening interest rates. The operations of non-bank
participants including FIs, mutual funds and insurance companies that were participating in the
call/notice money market are in the process of being gradually reduced according to pre-set norms. Such
an ultimate goal of making a pure inter-bank call money market is linked to the operationalisation of the
CCIL and attracting non-banks also into an active repo market. The effectiveness of LAF thus will be
strengthened with a pure inter-bank call/notice money market in place coupled with growth of repo
market for non-bank participants. The LAF operations combined with judicious use of OMOs are
expected to evolve into a principal operating procedure of monetary policy of the Reserve Bank. To this
end, the Reserve Bank may have to reduce substantially the liquidity through refinance to banks and
PDs. For example, if the Reserve Bank intends to tighten the money market conditions through LAF, the
36

37. automatic access of refinance facility from the Reserve Bank to banks and PDs may reduce the
effectiveness of such an action and thereby cause transmission losses of monetary policy. It may be
appropriate to note that in most of the developed financial markets, the standing facilities operate at the
margin.
At present the Reserve Bank provides standing facilities comprising the support available to banks
under Collateralised Lending Facility (CLF) and export credit facility to banks, and liquidity support to
PDs. One way of reducing the standing facility will be to eliminate CLF from the standing facilities and
reducing the present ratio of normal and back-stop facilities. The existing methodology of calculating
eligible export credit refinance continues till March 2002 and the Reserve Bank has expressed its
intention of moving away from sector specific refinance. As CRR gets lowered and repo market
develops, the refinance facilities should also be lowered giving more effectiveness to the conduct of
monetary policy.
Highlights of the RBI’s
 Benchmark Repo Rate increased by 25 basis points (bps) from 8.25% to 8.50% with immediate effect;
Reverse Repo and Marginal Standing Facility stands revised to 7.50% and 9.50%, respectively
 Bank Rate, Cash Reserve Ratio and Statutory Liquidity Ratio unchanged at 6%, 6% and 24%
 Baseline projection for headline WPI inflation for March 2012 maintained at 7%; inflation expected to
remain sticky in October-November 2011 and decline from December 2011 onwards
 Baseline projection for GDP growth for FY12 revised to 7.6%; in September 2011, the RBI had
indicated downside risks to its growth projection of 8% for 2011-12 made in May 2011 and July 2011,
led by moderating domestic demand and impact of weakening global growth momentum and rising
uncertainty
 Monetary stance remains focused on containing inflation and anchoring inflationary expectations,
whilst aiming to balance growth concerns
 Guidance provided regarding a low likelihood of a further policy rate hike in December 2010
37

38.  Interest on savings account balances deregulated - Banks allowed to offer differential rates for savings
deposits beyond Rs. 1 lakh; Deregulation could trigger increase in cost of funds for Banks
 Non-food credit and broad money growth projections retained at 18% and 15.5%, respectively.
.Systemic liquidity remains within RBI
Systemic liquidity remained in deficit mode throughout Q2FY12, but largely remained within RBI’s
comfort zone of +/-1% of net demand and time liabilities, with the exception of a few days in September
2011 on account of pressures related to advance tax payments. The Marginal Standing facility (MSF)
introduced by RBI in May 2011 available to Banks at 1% higher than Repo rate has been largely
unutilized, as Banks were able to access adequate liquidity through the LAF.
Banks maintained average excess SLR investments (including Reverse Repo) of more than Rs.
2.7 lakh-crore during H1FY12, marginally lower than 2.9 lakh-crore in H1FY11. The average SLR
levels remained around 28.8% of NDTL as against the mandated 24%. GoI spending during the first half
has remained high as indicated by the negative balance with RBI since April 2011 despite achieving 61%
of FY12’s gross market borrowings in up to October 14, 2012. However, the full year GoI borrowing
target has been revised upwards by about Rs. 53,000 crore which means the GoI’s gross market
borrowing in H2FY12 would be around Rs. 2.03 lakh-crore. This could exert some pressure on systemic
liquidity particularly if credit demand remains benign.
38

39. CHAPTER-4
FUNCTIONS OF COOPERATIVE BANK
39

40. Functions of Banks
The functions of banks are of two types.
(A) Primary functions; and
(B) Secondary functions.
Let us discuss details about these functions.
(i) Primary functions
The primary functions of a bank include:
a) Accepting deposits; and
b) Granting loans and advances.
a) Accepting deposits
The most important activity of a commercial bank is to mobilize deposits from the public. People who
have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon
the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow
along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds
with the bank. There is also safety of funds deposited with the bank.
b) Grant of loans and advances
The second important function of a commercial bank is to grant loans and advances. Such loans and
advances are given to members of the public and to the business community at a higher rate of interest
than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances
varies according to the purpose and period of loan and also the mode of repayment.
40

41. i) Loans
A loan is granted for a specific time period. Generally commercial banks provide short-term loans. But
term loans, i.e., loans for more than a year may also be granted. The borrower may be given the entire
amount in lump sum or in installments. Loans are generally granted against the security of certain assets.
A loan is normally repaid in installments. However, it may also be repaid in lump sum.
ii) Advances
An advance is a credit facility provided by the bank to its customers. It differs from loan in the sense that
loans may be granted for longer period, but advances are normally granted for a short period of time.
Further the purpose of granting advances is to meet the day-to-day requirements of business. The rate of
interest charged on advances varies from bank to bank. Interest is charged only on the amount withdrawn
and not on the sanctioned amount.
Types of Advances
Banks grant short-term financial assistance by way of cash credit, overdraft and bill discounting.
Let us learn about these.
a) Cash Credit
Cash credit is an arrangement whereby the bank allows the borrower to draw amount up to a specified
limit. The amount is credited to the account of the customer. The customer can withdraw this amount as
and when he requires. Interest is charged on the amount actually withdrawn. Cash Credit is granted as
per terms and conditions agreed with the customers.
b) Overdraft
Overdraft is also a credit facility granted by bank. A customer who has a current account
with the bank is allowed to withdraw more than the amount of credit balance in his account. It is a
temporary arrangement. Overdraft facility with a specified limit may be allowed either on the security of
assets, or on personal security, or both.
41

42. c) Discounting of Bills
Banks provide short-term finance by discounting bills that is, making payment of the amount before the
due date of the bills after deducting a certain rate of discount. The party gets the funds without waiting
for the date of maturity of the bills. In case any bill is dishonored on the due date, the bank can recover
the amount from the customer.
ii) Secondary functions
In addition to the primary functions of accepting deposits and lending money, banks perform a number of
other functions, which are called secondary functions.
These are as follows;-
a. Issuing letters of credit, traveler’s cheque, etc.
b. Undertaking safe custody of valuables, important document and securities by providing
Safe deposit vaults or lockers.
c. Providing customers with facilities of foreign exchange dealings.
d. Transferring money from one account to another; and from one branch to another
branch of the bank through cheque, pay order, demand draft.
e. Standing guarantee on behalf of its customers, for making payment for purchase of
goods, machinery, vehicles etc.
f. Collecting and supplying business information.
g. Providing reports on the credit worthiness of customers.
i. Providing consumer finance for individuals by way of loans on easy terms for purchase
of consumer durables like televisions, refrigerators, etc.
j. Educational loans to students at reasonable rate of interest for higher studies, especially
for professional courses.
E-banking (Electronic Banking)
With advancement in information and communication technology, banking services are also made
available through computer. Now, in most of the branches you see computers being used to record
banking transactions. Information about the balance in your deposit account can be known through
computers. In most banks now a day’s human or manual teller counter is being replaced by the
42

43. Automated Teller Machine (ATM). Banking activity carried on through computers and other electronic
means of communication is called ‘electronic banking’ or ‘e-banking’. Let us now discuss about some of
these modern trends in banking in India.
Automated Teller Machine
Banks have now installed their own Automated Teller Machine (ATM) throughout the country at
convenient locations. By using this, customers can deposit or withdraw money from their own account
any time.
Debit Card
Banks are now providing Debit Cards to their customers having saving or current account in the banks.
The customers can use this card for purchasing goods and services at different places in lieu of cash. The
amount paid through debit card is automatically debited (deducted) from the customers’ account.
Credit Card
Credit cards are issued by the bank to persons who may or may not have an account in the bank. Just like
debit cards, credit cards are used to make payments for purchase, so that the individual does not have to
carry cash. Banks allow certain credit period to the credit cardholder to make payment of the credit
amount. Interest is charged if a cardholder is not able to pay back the credit extended to him within a
stipulated period. This interest rate is generally quite high.
Net Banking
With the extensive use of computer and Internet, banks have now started transactions over
Internet. The customer having an account in the bank can log into the bank’s website and access his bank
account. He can make payments for bills; give instructions for money transfers, fixed deposits and
collection of bill, etc.
Phone Banking
In case of phone banking, a customer of the bank having an account can get information of his account;
make banking transactions like, fixed deposits, money transfers, demand draft, collection and payment of
bills, etc. by using telephone. As more and more people are now using mobile phones, phone banking is
possible through mobile phones. In mobile phone a customer can receive and send messages (SMS) from
and to the bank in addition to all the functions possible through phone banking.
43

44. CHAPTER-5
RESEARCH METHODOLOGY
44

45. RESEARCH METHODOLOGY
Introduction
Redman and Moray defines research as a “SYSTEMATIZED EFFORT TO GAIN NEW
KNOWLEDGE”. It may be noted, in the planning and development, that the significance of research lies
in its quality and quantity. Research methodology is the specification of accruing the information need to
structure or solve at hand. It is not concern to decision of the fact, but also building up to data knowledge
and to discover the new fact involve through the process of dynamic change in society.
DATA COLLECTION METHOD
Primary Data Collection
1- OBSERVATION METHOD
2-SURVEY METHOD
Secondary Data collection
To source of secondary data research requires exploring newspapers, magazines brought to the
workplace by recovery management and establishment department. It involves suffering of internet.
In my project report, I use Secondary data collection method.
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46. OBJECTIVES OF STUDY
1- To study the detail of monetary policy.
2- To under stand the problems faced by bank.
3- To know how monetary policy affects banks.
4- To know the effect on policies of bank by monetary policy.
5- To show how interest rates changes due to change in monetary policy.
6- To study current monetary policy session 2011-2012.
7- To know the services provided by cooperative bank to their customers.
8- To know the terms like CRR, SLR.
46

47. CHAPTER-5
EFFECT OF MONETARY POLICY ON BANKS
47

48. Interest
rates
1- RBI's
deregulation
drive on
saving interest
rates has
created a
competitive
environment
across banks
in an effort to
retain and
capture a loyal
customer base.
The second
quarter of the
monetary
policy review
instructed
banks to
implement
deregulation
of savings
bank rates
with
immediate
effect,
allowing
banks to set
their own interest rates. The rate of interest in savings bank account was
four per annum as mandated by the government in May 2011.
However with the recent change banks are now allowed to fix their interest
rates for saving account customers. Banks now use this as a competing
factor and weave it into their merits to enhance their customer base.
2- The happy news for savings account holders is maximum benefits for
their money irrespective of the time period. Before deregulation there was
hardly any competition in this segment, and all banks offered the same rate
of interest. So, there were no second thoughts for customers about shifting
their savings account from one bank to another. However, now customers
think twice before they start a new account or wish to switch an existing
account to get the maximum benefits.
Many wonder how banks calculate their savings account interest. Let us
understand this process with an example: Earlier banks used to pay an
interest rate of four per cent per annum against the lowest available balance
in the account between the 10th and final day of a month.
3- Any deposits happening during this period were not eligible for interest
rate calculation of that month, but at the same time, withdrawals during the
period were taken into account.
For instance, Vishal had a balance of Rs 50,000 in his account as on
January 10. On January 20, he received Rs 100,000 as maturity bonus for
his LIC policy. On January 28, he had withdrawn Rs 125,000 for making a
down payment for his new flat, thereby reducing his account balance to Rs
25,000.In his case, the bank would consider Rs 25,000 for interest
calculation, as it is the lowest amount available in his account between 10
and 28 January.
48

49. Implications of bank ownership for the credit channel of
monetary policy transmission: Evidence from India
1. Introduction
The recent financial crisis brought to the fore the debate about the bank lending channel of monetary
policy transmission. Traditional macroeconomic models such as the IS-LM representation assume that
monetary policy affects the real economic activity by changing interest rates which, in turn, affects the
investment demand of the firms. However, this line of argument has increasingly come under scrutiny.
To begin with, evidence suggests that investment decisions of firms are affected much more by factors
such as cash flows than by the cost of borrowing (Bernanke and Gertler, 1995). Evidence also suggests
that banks are not passive intermediaries between the central bank and end users of money such as the
Firms.
For example, in an early discussion of this issue, Bernanke and Blinder (1992) demonstrate that the
composition of banks’ portfolios change systematically in response to monetary policy initiatives. They
conclude that the impact of monetary policy on the investment of firms is not entirely demand driven,
and that at least part of it can be explained by the supply side or the bank lending channel. Kashyap and
Stein (1993) demonstrate that if a central bank pursues tighter monetary policy, there is a decline in the
amount of bank loans to
firms and simultaneously a rise in the issuance of commercial paper, and include that contractionary
monetary policy reduces loan supply. Importantly, research suggests that there might be significant
heterogeneity in the reaction of banks to monetary policy initiatives. It may, for example, depend on the
extent of competition in the banking sector. Olivero, Li and Jeon (2011) argue that an increase in
competition in the banking sector weakens the transmission mechanism of monetary policy through the
bank lending channel.
Banks’ reaction to monetary policy initiatives also depends on the quality of their balance sheets. Peek
and Rosengren (1995) argue that an important determinant of a bank’s reaction would be its capital-to-
asset ratio. If banks find it difficult (or expensive) to raise capital, for example, they could be reluctant to
49

50. lend even if there is ample demand for credit in the aftermath of easing of monetary policy. This
hypothesis finds support in the empirical litera- ture. Kishan and Opiela (2000) find that small and
undercapitalized banks are most affected by monetary policy. Gambacorta (2005) too finds that lending
of undercapitalized Italian banks is adversely affected by contractionary monetary policy, even though
lending is not correlated with bank size. Further, there is a directional asymmetry in the impact of
monetary policy on the lending behaviour of undercapitalised banks (Kishan and Opiela, 2006). In the
event of contractionary monetary policy, there is a sharp tightening in loan disbursal by undercapitalised
banks, but in the event of an expansionary monetary policy there is no corresponding expansion of credit
disbursal.
The reaction of banks to monetary policy also depends on the composition of their assets. The
traditional or money view of monetary policy transmission assumes that all asset classes are perfect
substitutes of each other. If, therefore, contractionary monetary policy leads to a reduction in deposits, a
bank is capable of substituting for this loss of deposits dollar for dollar, using other assets like CDs, such
that loan supply is not affected. Stein (1998) argues that, contrary to this view, assets included in a
bank’s balance sheet are not perfect substitutes. For example, since deposits are guaranteed by the FDIC
(or its overseas counterpart), while CDs are not, there may be adverse selection in the market for CDs,
such that banks do not use these instruments to compensate for loss of deposits dollar for dollar. This
results in a decline in loan supply. It follows that banks that have less liquid assets such that t hey cannot
quickly and costlessly compensate for loss of deposits in the event of contractionary monetary policy or,
alternatively, those that cannot raise funds quickly to the same end, would react more to monetary policy
changes. Kashyap and Stein (2000) find that monetary policy has greater impact on loan supply of banks
with low securities-to-assets ratios. The literature does not, however, empirically examine the impact of
bank ownership on the lending channel of monetary policy transmission.
This is hardly surprising, given that much of the literature is based on the United States and Western
European experiences, where private ownership of banks overwhelmingly dominates. However, as
pointed out by La Portal et al. (2002), State-ownership of banks is ubiquitous in much of the world,
especially in emerging economies. Indeed, the 2007–09 financial crises has led to significant state-
ownership of banking assets even in developed countries such as the United Kingdom, and concerns
about the lending activities of the de facto nationalised banks have brought into focus the impact of bank
ownership on the lending channel in the developed country context as well. In this paper,
50

51. we address this lacuna in the literature, and examine whether the impact of monetary policy on lending
differs across banks with different ownerships.
Studying how bank ownership plays a role in the credit channel of monetary policy transmission
is important because public sector banks account for a significant portion of the banking assets and loan
portfolio emerging economies, and, at the same time, many of these country are fiscally constrained such
that monetary policy may be the only instrument available to policy makers to induce growth. This
indeed is currently the situation in a wide range of developed countries as well. Our analysis provides an
empirical basis for this policy debate concerning the relative effectiveness of monetary policy when a
significant proportion of the banking sector is under state ownership. This is one of the key contributions
of the paper.
Further, by isolating the response of foreign owned banks, it adds to the small but growing
literature on the impact of foreign banks on credit growth, especially in emerging economies context.
Our second important contribution is that we separately examine the reaction of different types of banks
(i.e., private, state and foreign) in easy and tight monetary policy regimes. As mentioned
Earlier, reaction of banks to monetary policy changes may be asymmetric:
a change in interest rates might have very different outcomes, depending on whether these rates are low
or high to begin with. If an asymmetry does exist, a greater understanding of the differences in the
impact of monetary policy in easy and tight money regimes would be imperative for successful monetary
policy interventions. The richness of our contribution is enhanced by the fact that, for each of these
monetary policy regimes, we estimate the reaction of the different types of banks based on ownership.
Finally, we examine whether impact of monetary policy differs With respect to different
maturities, and hence riskiness, of lending activities. Specifically, we examine the impact of monetary
policy on disbursal of (more risky) medium term credit and (less risky) short-term credit. We estimate
the impact for tight and easy monetary regimes, and also for the different types of banks. We use bank-
level data from India to examine these issues. We focus on India for several reasons. First, India is a fast
growing emerging market that embraced the market economy in the early nineties and has since
liberalized its economy substantially. Importantly, in the absence of a well developed market for
corporate bonds, banks are by far the largest source of credit for Indian companies, and hence bank
lending plays an important role in the transmission of monetary policy in India. Second, the Indian
banking sector is also marked by the presence of a number of state-owned and private-owned (including
foreign) banks, who compete on a level playing field. Third, the state-owned banks themselves have
51

52. autonomy regarding lending decisions, and many of them have sold shares to private (and even foreign)
shareholders, thereby opening themselves up to greater scrutiny. Indeed, Indian state-owned banks
resemble the de facto nationalized banks of the United Kingdom much more closely than state-owned
banks in former transition economies of Central and Eastern Europe (see, e.g., Bonin and Wachtel,
2002).
Reaction Of Cooperative
There is a fairly large literature on the bank lending channel of monetary policy. But much of this
literature is in the context of the United States, Europe and other developed economies where the banks
are heterogeneous but are almost entirely in private sector. The emerging market economies, by contrast,
have their fair share of state-owned banks, such that, in these contexts, the implications of ownership for
the bank lending channel remains an important, yet largely unexplored, policy consideration. In this
paper we address this issue, using bank-level data from India. Our results suggest that there are
considerable differences in the reactions of different types of banks to monetary policy initiatives of the
central bank. During periods of tight monetary policy, as captured by the monetary conditions index,
state-owned banks, old private banks and foreign banks curtail credit in response to an increase in
interest rate. The reaction of foreign banks is particularly sharp.
The reaction of the new private banks is not statistically significant. By contrast, during easy
money periods, an increase in interest rates by the central bank leads to an increase in the growth of
credit disbursed by old private banks, with no significant reactions from other types of banks. The
regression results
also indicate that the adverse reaction to a policy initiated increase in interest rate in a tight monetary
regime is much greater for medium term borrowing than for short-term borrowing. Our results have two
significant implications for the literature on bank lending channel. First, it suggests that the bank lending
channel of monetary policy might be much more effective in a tight money period than in an easy money
period. In other words, if interest rates are low, then a central bank that desires monetary contraction may
have to raise the rate substantially to witness an impact on money supply through the bank lending
channel. This has implications for future analyses of the bank lending channel; the condition under which
52

53. a central bank changes its policy rate should be explicitly taken into account. It has also implications for
the implementation of monetary policy strategies during a business cycle period or economic crisis.
For example, if the economy is going through a downturn and the authorities try to stimulate the
economy towards the recovery zone, then, depending upon the type of money regime the economy is in,
the policymakers need to consider making adjustments in policy rates to get the desired effects.
Indian Banks - The Effects of Confused Monetary Policy
Confused! That’s what I would call the present state of Indian monetary policy today. While
normally the Reserve Bank of India decides monetary policy and banks factor it into their
lending and deposit rates, the present situation in India is very different. The Government wants
banks to follow a policy which is at variance with the policy of the Central Bank. The
Government by asking banks not to pass on the effects of the interest rate hike by the
Reserve Bank of India to their constituents unless they follow a particular procedure reminds
one of the days of the license permit raj which prevailed in India till the early 1990's when
the present state of liberalization started. While it is too early to say that Indian reforms are
being derailed, yet attempts like this by the Finance Ministry are bound to have adverse effects
on the Indian Economy and securities markets.
It was only in may this year that the Indian securities markets went into tailspin when the
Government tried to bring in taxes through the administrative route. This new use of
administrative authority in the commercial decisions of banks is bound to have an adverse
effect on share values , bank profitability and allocation of resources in the economy. Bank
share prices reportedly fell three percent in one day on account of the latest attempt by the
Government to micromanage the banks.
As a result of this latest directive of the Government, the public sector banks are confused
and are putting all loan decisions on hold. This is bound to have an effect on the availability
53

54. of funds in the economy for trade, industry and consumption. The fallout of
this could be catastrophic Analysts should keep a watch on the efforts of the Finance Ministry to
micromanage the Indian economy as in my view this is today the latest challenge for the
Indian economy - continue to perform in the face of increased government intervention.
The Reserve Bank of India's third quarter review of monetary policy was devoid of major surprises. The
only change in monetary policy instruments — a cut in the Cash Reserve Ratio (CRR) by 0.50
percentage point to 5.5 per cent — was largely expected. The move will release Rs.32, 000 crore of
funds impounded from banks, almost immediately. The key policy interest rate, the repo rate, remains
unchanged at 8.5 per cent. Consequently, the reverse repo stays at 7.5 per cent and the marginal standing
facility at 9.5 per cent. A cut in the repo rate would have more definitely indicated a downward shift in
the monetary stance but the RBI has argued that the CRR reduction is the best it could do under the
prevailing circumstances and ought to be interpreted as a signal for a softer monetary policy regime.
According to the RBI, the CRR is a policy instrument with liquidity dimension. Its reduction will bring
down the cost of money for banks and have a bearing on their ability to lend at lower rates. It may well
be so but, for most market participants, a repo rate reduction would be the more authentic signal. Soon
after the policy announcement on Tuesday, attention has immediately shifted to how soon the RBI will
act in that direction.
The reasons
The RBI has cited three well known reasons in support of its latest stance. Economic growth is
decelerating due to the combined impact of uncertain global environment, cumulative effect of past
monetary tightening and domestic policy uncertainty.
(a) While some slowdown in the growth of demand was expected as a result of earlier monetary policy
moves to control inflation, at this juncture risks to growth have increased.
(b) The fall in WPI inflation is due to a sharp decline in the prices of seasonal vegetables. However,
protein-based food items and non-manufactured food inflation remain high. Further, there are many
upside risks to inflation. Global petroleum prices remain high. The lingering effect of recent rupee
depreciation continues and there is a significant slippage in the fiscal deficit.
54

55. (c) Liquidity conditions have remained tight beyond the comfort zone of the RBI despite massive
infusions through open market operations.
All these have tied RBI's hands and postponed its decision to cut the repo rate. Less clear is what the half
a percentage point cut in the CRR will do to ease liquidity as a critical step towards making banks lend
more. Some analysts, notably A. Seshan (former senior RBI official), see an inherent contradiction in the
policy statement: how does a situation of liquidity shortage co-exist with low credit off take from the
banking system?
‘A crowding out' effect
Consider the following: Money supply has been on expected lines but non-food credit growth at 15.7 per
cent has been below the indicative projection of 18 per cent. The latter is due to the combined impact of a
slowing economy and risk aversion among banks concerned over non-performing assets (NPAs). There
is also ‘a crowding out' effect of increased government borrowing. Net credit to government has
increased at a significantly higher rate of 24.4 per cent as compared with 17.3 per cent last year. The last
point may be one of the reasons to explain the tightness in the money market. But the RBI has done its
bit to ease liquidity by buying back dated securities, for instance. Far more difficult it is to reconcile low
credit off take with liquidity shortage.
The only explanation is that banks have become even more shy of lending than is apparent. As pointed
out earlier, an increase in the NPAs does contribute to increased risk aversion among banks. There is also
a widespread fear psychosis: the bona fide commercial decisions of bankers are being questioned many,
many years later.
Power sector in deep trouble
A number of infrastructure sectors, especially power, are mired in deep financial troubles.
Telecom is in a mess. More recently, Kingfisher Airlines and Air India have shown how deep-seated the
financial problems are even in a sunrise sector such as civil aviation.
55

56. Aversion to lending
Many times in the past too, risk aversion on the part of banks has been cited to explain the fall in lending.
Given the dominance of government banks, it is of utmost importance to put in place a system of
accountability, which will not penalize risk-taking.
In short, the RBI's betting on a CRR cut as a means of assuaging the disappointment over the absence of
more overt repo rate reduction might have paid off in the short run. Stock markets are up. But for the
CRR cut draws attention to some structural blocks such as risk aversion that will limit its potential.
Rural Co-operatives
Licensing of Co-operatives
1- The Committee on Financial Sector Assessment (Chairman: Dr. Rakesh Mohan and Co-Chairman: hri
Ashok Chawla) had recommended that rural co-operative banks, which failed to obtain a licence by end-
March 2012, should not be allowed to operate. The Reserve Bank, along with the National Bank for
Agriculture and Rural Development (NABARD) implemented a roadmap for issuing licences to
unlicensed state co-operative banks (StCBs) and district central co-operative banks (DCCBs) in a non-
disruptive manner, to ensure the completion of licensing work by end-March 2012. After considering the
NABARD’s recommendations for issuance of licences based on inspection/quick scrutiny, one out of 31
StCBs and 41 out of 371 DCCBs were found to be unable to meet the licensing criteria by end-March
2012. In this regard, suitable action will be initiated in due course.
Streamlining of Short-Term Co-operative Credit Structure
2- After recapitalisation of the three-tier short-term co-operative credit structure (STCCS), 41 DCCBs
having high level of financial impairment as of end-March 2012 were unable to meet the licensing
criteria. In order to examine issues of structural constraints and explore strengthening of the rural co-
operative credit architecture with appropriate institutions and instruments of credit to fulfil credit needs,
it is proposed:
56

57.  to constitute a Working Group to review the STCCS, which will undertake an in-depth analysis of the
STCCS and examine various alternatives with a view to reducing the cost of credit, including feasibility
of setting up of a two-tier STCCS as against the existing three-tier structure.
Urban Co-operative Banks
Exposure of UCBs to Housing, Real Estate and Commercial Real Estate
1- At present, UCBs are permitted to assume aggregate exposure on real estate, commercial real estate
and housing loans up to a maximum of 10 per cent of their total assets with an additional limit of 5 per
cent of their total assets for housing loans up to `1.5 million. In order to facilitate enhanced priority
sector lending, it is decided:
 To permit UCBs to utilise the additional limit of 5 per cent of their total assets for granting housing
loans up to `2.5 million, which is covered under the priority sector.
2- 77. Detailed guidelines in this regard will be issued separately.
Licences for Setting up New Urban Co-operative Banks
1- As announced in the Monetary Policy Statement of April 2010, an Expert Committee (Chairman: Shri
Y. H. Malegam) was constituted in October 2010 for studying the advisability of granting licences for
setting up new UCBs. The Committee was also mandated to look into the feasibility of an umbrella
organization for the UCB sector. The Committee submitted its report in August 2011. The report was
placed in public domain in September 2011 for comments and suggestions from stakeholders. In the light
of the feedback received, it is proposed.
57

58. Highlights of the RBI’s Second Quarter Review of Monetary Policy for 2011-12 –
October 2011
 Benchmark Repo Rate increased by 25 basis points (bps) from 8.25% to 8.50% with immediate effect;
Reverse Repo and Marginal Standing Facility stands revised to 7.50% and 9.50%, respectively
 Bank Rate, Cash Reserve Ratio and Statutory Liquidity Ratio unchanged at 6%, 6% and 24%
 Baseline projection for headline WPI inflation for March 2012 maintained at 7%; inflation expected to
remain sticky in October-November 2011 and decline from December 2011 onwards
 Baseline projection for GDP growth for FY12 revised to 7.6%; in September 2011, the RBI had
indicated downside risks to its growth projection of 8% for 2011-12 made in May 2011 and July 2011,
led by moderating domestic demand and impact of weakening global growth momentum and rising
uncertainty
 Monetary stance remains focused on containing inflation and anchoring inflationary expectations,
whilst aiming to balance growth concerns
 Guidance provided regarding a low likelihood of a further policy rate hike in December 2010
 Interest on savings account balances deregulated - Banks allowed to offer differential rates for savings
deposits beyond Rs. 1 lakh; Deregulation could trigger increase in cost of funds for Banks
 Non-food credit and broad money growth projections retained at 18% and 15.5%, respectively.
58

59. Systemic liquidity remains within RBI comfort zone; large government borrowings in H2FY12
could exert some pressure
Systemic liquidity remained in deficit mode throughout Q2FY12, but largely remained within RBI’s
comfort zone of +/-1% of net demand and time liabilities, with the exception of a few days in September
2011 on account of pressures related to advance tax payments. The Marginal Standing facility (MSF)
introduced by RBI in May 2011 available to Banks at 1% higher than Repo rate has been largely
unutilized, as Banks were able to access adequate liquidity through the LAF.
Banks maintained average excess SLR investments (including Reverse Repo) of more than Rs.
2.7 lakh-crore during H1FY12, marginally lower than 2.9 lakh-crore in H1FY11. The average SLR
levels remained around 28.8% of NDTL as against the mandated 24%. GoI spending during the first half
has remained high as indicated by the negative balance with RBI since April 2011 despite achieving 61%
of FY12’s gross market borrowings in up to October 14, 2012. However, the full year GoI borrowing
target has been revised upwards by about Rs. 53,000 crore which means the GoI’s gross market
borrowing in H2FY12 would be around Rs. 2.03 lakh-crore. This could exert some pressure on systemic
liquidity particularly if credit demand remains benign.
59