Money Market Reforms in India

March 24, 2015 June 28, 2017

Reserve Bank of India is the biggest regulator of the Indian markets. It controls the monetary policy of India. Its control is however limited to the organised part of economy and the unorganised sector which has a significant presence is largely unregulated. RBI frequently introduces many reforms to bolster the Indian economy which is in a state of constant flux and is continuously evolving. The major money market reforms came after the recommendations of S. Chakravarty Committee and Narsimham Committee. These were major changes which helped unfold the banking potential of India and shape our financial institutions to world class standards. It was soundness of these reforms which helped our economy to easily tide over the economic crisis which had gripped the world in 2008. These are discussed below:

Deregulation of Interest Rates

Interest rates are now subject to market conditions as the ceiling limit on them have been removed by RBI after 1989.The important interest rates in India are-Bank rate, Medium-term lending rate, Prime Lending rate, Bank Deposit rate, Call rate, Certificate of Deposit rate, Commercial paper rate etc. This deregulation got a major push after the economic liberalisation of 1991. Chakravarty Committee was a strong proponent of free and flexible interest rates to promote savings, investments, government financial system and stability. RBI removed the upper ceiling of 16.5% and instead fixed a minimum of 16% per annum. The rates were further relaxed after the Narasimhan Committee report in 1991.

Reforms in Call and Term money market

The reforms in call and term money market were done to infuse more liquidity into the system and enable price discovery. RBI undertook several important steps to check the constraints and remove them systematically. It was in October 1998, RBI announced that non-banking financial institutions should not participate in call/term money market operations and it should purely be an interbank operating segment and encouraged other participants to migrate to collateralised segments to improve stability. Also, reporting of all call/notice money market transactions through negotiated dealing system within 15 minutes of conclusion of transaction was made mandatory. The volume of operations in this segment was not increased much even after the reforms.

Introduction of new money market instruments

RBI introduced many new market instruments to diversify the market. These were certificates of deposit in 1989, commercial papers in 1990 and interbank participation certificates with/without risk in 1988.

Setting up Discount and Finance House of India

Discount and Finance House of India was set up in 1988 to impart more liquidity and also further develop the secondary market instruments. However, maturities of existing instruments like CDs and CPs were gradually shortened to encourage wider participation. Likewise ad hoc treasury bills were abolished in 1997 to stop automatic monetisation of fiscal deficit.

Introducing Liquidity Adjustment Facility

RBI introduced a Liquidity Adjustment Facility in June 2000 which was operated through fixed repo and reverse repo rates. This helped establishment of interest rate as an important monetary instrument and granted greater flexibility to RBI to respond to market needs and suitably adjust liquidity in the market. Repo and Reverse Repo rates were introduced in 1992 and 1996 respectively.

Refinance by RBI

This is a potent tool by RBI to meet the any liquidity shortages and for credit control to select sectors. The export credit refinance facility to banks is provided under Section 17(3) of RBI Act 1934. It is available to all scheduled commercial banks who are authorised to deal in foreign exchange and have extended export credit. The SCBs are prvided export credit to the tune of 50% of the outstanding export credit. The concept of directed credit was also changed as the Narasimhan Committee recommended reduction of directed credit from 40 to 10%. It also suggested narrowing of priority sector and realigning focus to small farmers and low income target groups. The refinance rate is linked to bank rate.

Regulation of Non-Banking Financial Companies

RBI Act was amended in 1997 to bring the NBFCs under its regulatory framework. A NBFC is a company registered under Companies Act, 1956 and is involved in making loans and advances, acquisition of shares, stocks, bonds, securities issued by government etc. They are similar to banks but are different from the latter as they cannot accept demand deposits and cannot issue cheques. They have to be registered with RBI to operate within India. There are a host of regulations which NBFCs have to follow to smoothly operate within India like accept deposit for a minimum period, cannot accept interest rate beyond the prescribed rate given by RBI.