Regulatory framework

Monetary Policy
Set 19

P C Narayan

IIMB PCN BFMS L19

Regulatory Framework for Banks

World-over, Banking sector is regulated more
closely than any other sector:
Banks hold a major portion of public savings
Banks intermediate between savers and borrowers
Banks administer the payments and settlements
system
Banks hold a large part of the money supply and hence
become the channel for implementing monetary policy
Problems in the Banking sector are rapidly transferred
to the entire financial system and the economy and
vice versa

Reserve Bank of India Act of 1934 and Banking

Regulations Act of 1949 were formulated to
regulate the Banking Sector in India
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Role of Reserve Bank of India

Role as a Central Bank:
Bankers to the Govt.
Currency issue function
Lender of Last Resort: RBI will meet all the reasonable
demands for financial accommodation from the
commercial banks

Promotional role of RBI:

Development of financial markets, i.e. developing the
marketplace and the market players
Key role in establishing FIs like NABARD, NHB, EXIM
Bank, etc.
IIMB PCN BFMS L19

Role of Reserve Bank of India

Regulatory role of RBI:
Control the price levels in the economy
Maintain the value of the Indian Rupee
Ensure a sound and healthy banking system through liquidity and
capital adequacy measures
Control credit flow through monetary and credit policy
Evaluate and approve expansion of Banks business as well as
mergers and acquisitions

Supervisory role of RBI:

Department of Banking Supervision and a separate Board for
Financial Supervision
Includes on-site verification (inspection) and off-site surveillance
and monitoring (Banks furnishing reports to RBI on a quarterly
basis)
CARMELS ( capital adequacy, asset quality, risk management,
management, earnings, liquidity and systems)
IIMB PCN BFMS L19

Central Banks worldwide

Liabilities:
Currency in circulation
Reserves

Assets:
Government Loans
Discount Loans/ Refinance

Federal Reserve System (USA) . The

benchmark among Central Banks
Bank of England/ Deutsche Bundesbank/
Bank of Japan
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Degree of independence of Central

Banks Case for independence

Subjecting to political pressure would impart an inflationary bias to the

Monetary Policy. A politically insulated Central Bank is more likely to
work on long term objectives like a sound currency and price stability
Political business cycle: Prior to elections most Governments
pursue expansionary policies to lower unemployment and interest
rates. After the elections high inflation and high interest rates!
Central Bank under the control of Finance Ministry
(Exchequer/Treasury) could make this cycle more pronounced.
Independent Central Bank can better resist the borrowings by govt.
and thus hold interest rates in check
Principal-Agent problem ( Politicians/ Govt. are the Principal and the
Central Bank is the Agent)
An independent Central Bank can be the conduit to pursue policies
that are politically unpopular yet in public interest
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Degree of independence of Central

Banks Case against independence
Accountability of the Central bank
Need for monetary policy to be in sync with
fiscal policy, the latter is the responsibility of the
Govt.
Will the Central bank use its freedom judiciously?
----------------------------------------------------------------- Public support for an independent Central bank
has been growing in most countries
Direct correlation between inflation and
independence of Central bank
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Monetary Policy

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Goals of Monetary Policy

Economic growth
Price Stability (controlling inflation)
Interest rate stability
Stability of Financial Markets
Stability in Foreign exchange rates
Employment
----------------------------------------------------------------Monetary Policy most often involves
managing the conflict among the above
IIMB PCN BFMS L19
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goals

Tools of Monetary Policy

Changes in Reserve requirements
SLR and CRR requirements

Open Market Operations:

Primary determinants of change in the reserves in the
banking system as well as interest rates
OM purchase/ sale by RBI leads to decline/expansion in
money supply
OMO is precise and flexible
OMO can be easily reversed
Easy to implement

Discounting / Refinance ( increasingly less

relevant)
IIMB PCN BFMS L19

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Strategy for Monetary Policy

Easier to pursue a monetary policy goal by aiming
at targets rather than at the goal itself
Operating target and intermediate target
NASA analogy: positioning spacecraft correctly as
it leaves the atmosphere ( operating target)
If spacecraft is off course,engineers will adjust its
thrust ( policy tool) to get it back on target
NASA will check position of the spacecraft again,
say , halfway to the moon (intermediate target) and
take mid-course corrections , if necessary
Money supply / reserves / interest rates
Inflation targeting
IIMB PCN BFMS L19

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Equity Market
Regulatory framework
Need arose in the early 90s due to deficiencies in
the Equity market:

Underdeveloped secondary market

Insider trading menace
Price manipulation
Inadequate financial disclosures
Lack of adequate instruments
Uncontrolled share broking
Unofficial trading
Lack of institutional support
IIMB PCN BFMS L19

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Securities and Exchange

Board of India (SEBI)
SEBI was set up in 1988
To protect the interest of investors in equity
To develop and regulate the equity market in India

Activities:

Registration of Brokers and sub brokers

Regulating of merchant bankers
Regulating mutual funds
Insider trading regulations
Portfolio manager regulations
IIMB PCN BFMS L19

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SEBI
Activitiescontd
Disclosures and investor protection

Draft prospectus
Debenture disclosures
Compulsory subscription by Promoters
Credit rating
Reservations

Surveillance
Screen based trading
Pan-India operation
Ensuring that SEs prescribe safeguards such
margins,capital adequacy, intra-day trading limits etc.
SEs to set up clearing house

Monitor working of S E s
Debar / penalise members/ brokers of S E s who
are found to violate the laws and guidelines
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THE END ! ! !
Thank you for your
participation! ! ! !

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