Impact of Policy Changes on Financial Stability of Commercial Banks in India
Paper Due date
Abstract
The study envisages financial stability of Indian Banks, especially schedule commercial banks, in the backdrop of macro-prudential policy changes. Banks are put under microscopic vision in terms of performing as commercial units while strictly adhering to the policy norms. The effect of regulatory and supervisory policy changes can be evidently seen in stressed performance of banks in the recent years, in-spite of growth in their retail portfolios. The policy changes of increased provisioning for NPAs, improvement in asset account quality, revised guidelines for Net Stable Funding Ratio, restructuring of large accounts and many more have been implemented in the banking system. Owing to these policy changes important financial indicators, such as, interest earnings, net profits, return on assets and more importantly return on equity, has shown a noteworthy drop. The question arises that though the policy measures are introduced to make banks more financial viable are not able to elevate their performance. Is it a short term effect which is going to reverse in near future? Also, the extent to which these policy changes will improve the financial stability of Indian banks?
Key words: Regulatory and Supervisory policy measures, Banking Stability Indicators (BSI), Scheduled Commercial Banks (SCBs), Return on Assets (RoA) and Return on Equity (RoE).
Introduction
In 2015 the Reserve Bank of India published its report on the analysis of the financial stability in the activity of the financial institutions in the country. This observation proved that the quality of the assets was diminishing while the central financial institution expected for the significant improvements with the application of the appropriate instruments and regulations (Rebello). Based on the outcomes of this research, the central bank of India should have changed current monetary policy and aim to the restoration of the viability of the banks. In fact, the financial system of India differs from the other countries because of the peculiarities of the livelihood of the people in this region, economic development of the country and several other factors affecting the performance of the banks. Besides, it should be noted that the banking financial structure is dependent on the regulatory regime and policy of the primary financial institution exercising the governance over the commercial banks in the country. From this point of view, this paper explores the actions and policies of the central bank of India in maintenance of the stability of the other commercial financial institutions in this country. The monetary policy of the central bank of India is taken from 2010 to nowadays in order to assess advantages and implications of the monetary strategies of the financial institution in comparison with the policies of the advanced states in promotion of the stability in the financial market. The issue of the usage of the monetary policy for the maintenance of the financial stability in the market was addressed also by the International Monetary Fund as the response of the international organization to the spread of the financial crisis. The crisis of 2008 brought the light to the financial organizations and several institutions that the application of the price stability lacks in maintenance of the stability in the country due to the fact that the local peculiarities of any region should be tackled by the central financial institution ("Monetary Policy And Financial Stability"). Therefore, the paper will investigate the role of the central bank in the promotion of the financial stability in the country based on the theoretical approaches and case study method limited to the peculiarities of the development of the financial market in India.
The role of Central Financial Institution in Maintenance of Financial Stability
The appearance of financial crisis usually undermines the stability of the financial crisis of particular country. In fact, the financial crisis can be of limited scope or affect the economic development of several states. In this respect, the central financial institution of any country cooperates with other state bodies in the limitation of the proliferation of the negative consequences of the financial crisis in favour of the maintenance of the stability. Besides, it should be noted that the central banks are usually quite limited in the availability of the resources and other capabilities that can be used for the restoration of the stability and limitation of the damages caused with the crisis. Despite the fact that the powers of the central financial institution are important in the regulation of the development of the crisis in the local economy, this state body can prevent the occurrence of this disaster. According to the theoretical background pertaining to the regulation of the financial crisis, it is necessary to state that the central banks have powers to cope with the increases rates of the systemic risks by introduction of the appropriate measures and policies in form of the security and stability amendments. Moreover, the central banks can refer to the application of the cycle-adjusted capital requirement ratios and other similar approaches in order to diminish speculation with the currency in the financial market and prevention of the negative effects to the business environment (Surbhi). However, at the stage of the ongoing development of the financial crisis in particular region, the only measures that can be used by the representatives of the central bank are the evaluation of the damages and possible prevention of their spill over on the entire economy of the country. With that, the central bank appears to be the only institution that has capabilities to alleviate spread of the risks in the financial system and restore the stability. This important objective can be achieved through the reduction of the panic in the actions of the other financial institutions in the country during the financial instability (Corbo).
The analysis of the scope of the measures existing before the central financial institution is important for the consideration of the efficiency of the policy of the Reserve Bank of India with the aim to restore stability in the country. One of the first measures that can be introduced by the central bank is the provision of the extensive liquidity support in favour of the ensuring the nature and quality of the collateral. Hence, the central bank should perform the functions of the creditor to the other financial institutions in order to supervise the flow of the financial resources through the country, their volumes. The other instrument that can be applied by the central bank is the establishment of the proper monetary policy rate. The state authorities of any country can consider about the maintenance of the necessary policy rate in mandatory way so that to reconsider demand of the consumers for the usage of particular currency and strengthening of the national currency. The abovementioned instruments are regarded as the most traditional measures for the stabilization of the situation in the currency market. However, at the own discretion of the national bank of any jurisdiction the non-traditional instruments can be used. For example, the bank can rely on the flexibility as the viable instrument and tool for the simplification of the process satisfaction of the collateral requirements and receipt of the credits. The usage of some of the measures or unique approach to the resolution of the problems in the financial market can assist to the central financial institution in the maintenance of the viability of the commercial banks in the country (Corbo).
Analysis of the Capacity of the Reserve Bank of India in Maintenance of Financial Stability and its Achievements
The central financial institution of India is called as the Reserve Bank of India. This bank is responsible for the development and implementation of the efficient monetary policy aimed to maintain stability in the financial market of the country. In fact, the Reserve Bank of India exercises surveillance over the actions of the financial institutions across the whole territory of the country. The primary objectives of the Reserve Bank of India (RBI) appear to contribute to the economic and financial prosperity of the country. By virtue of the policies and actions of the RBI, the stabilization of the price level should be achieved while the maintenance of the circulation of the exchange rate has the same importance of the RBI. Meanwhile, being the central financial institution obliges RBI to act in favour of the promotion of the economic activities in India ("Banking: Lesson 4 Structure Of The Indian Banking").
In reference to the functions of the RBI in the appraisal of the development of the financial market of the country, India adhered to the other countries in promotion of the interest in favour of improvement of the monetary stimulus. The innovative approach of the RBI in stabilization of the financial market and prevention of the similar crisis was started in 2015. The authorities introduced restriction on the volume of the reserves that can be held by the commercial financial institutions. This approach of the RBI was driven with the intention to achieve liberalization of the lending procedures in cooperation with the commercial institutions. Moreover, the board of the RBI took the decision that it is better to foster flow of the financial resources between the commercial banks rather than to allocate them in form of the governmental bonds. With that, the RBI pursued the interest to facilitate the amount of lending transactions and increase investment across the whole territory of the country with the participation of the central bank (Bradsher).
Along with these initiatives, the leadership of the RBI decided to maintain certain interest rate with its reduction to 0,25%. Despite the fact that this data is not significant, the governor of the RBI believed that this rate was enough for the maintenance of the interest of the commercial banks to contribute to the stabilization of the market. With that, the developments in the oil sector alleviated certain risk of the appearance of the rise in the level of inflation. Accordingly, the RBI took care of the statutory liquidity ration. This implies that the share of the demand deposits and relevant liabilities were defined as certain types of the reserves kept by the commercial institutions. From one side, the actions of the RBI are regarded as efficient. Although, some evident implications were not taken into account. Namely, there are certain obstacles in the finalization of the transition process of the commercial financial institutions to the lower interest rate in cooperation with the lenders. The introduction of changes by the commercial financial institutions resulted in the situation where they have to adjust to the changes within the following month. Besides, almost all types of these banks have coped with these challenges and met the expectations of the RBI in the contribution to the stabilization of the financial market (Bradsher).
The recent experience of the RBI in the application of the new monetary policy reaffirms the commitment of the central bank to take care of the situation in the financial market. The board of the RBI regularly reviews that effects of the measures taken under the comprehensive monetary policy and updates all commercial institutions on the same basis. Meanwhile, it should be noted that the commercial banks should respect the policy of the central bank because of the fact that these institutions perform the functions of the agents of the primary bank. While the central bank of India is not driven with the profit-oriented approach, this activity should be exercised by the commercial banks. Besides, it should be noted that the stabilization scheme of the RBI is still subject of the close investigation from the international financial experts because of the innovative side of the measures adopted by the RBI.
Market Stabilization Scheme of RBI
For the purposes of the achievement of the stabilization in the financial market, the RBI relies on the Market Stabilization Scheme titled as “MSS”. This strategy aims to support volume of necessary financial resources in the preservation of the reserve ratio. However, this requirement is strict enough as it limited viability of the commercial financial institutions in the financial system of India. In this respect, the RBI considers about withdrawal of this requirement in order to simplify business performance of the banks. The market stabilization package of measures was introduced by the RBI in 2004 on behalf of the government of India. The initial aim of this reform was to take care of the prevailing surplus in the financial system pertaining to the liquidity of the assets because of the several foreign exchange transactions. Hence, the RBI took decision to conduct sterilization of the liquidity of the commercial financial institutions so that to improve outcomes of the financial stability in reference to the performance of the commercial banks. In order to contribute to the implementation of this measure, the commercial banks had to use cash reserve ratio at the level of 100 per cent in relation to the deposits within given period of time. Although, the RBI still is in need to the supplementary liquidity that can be achieved through the establishment of the new ceiling on the cash reserve ratio. Despite the fact that the usage of this method can be widely criticized, there are several features confirming the availability of the benefits of this tool. In fact, the commercial banks can achieve to receive profit of higher interest rate rather than to rely on the savings bank interest as the other source of the revenue. At the same time, it is much important to recognize that current measures of the RBI have temporary nature because of the pursuit of the most suitable instruments for the financial market of India. Meanwhile, the application of the management bills (CMBs) and Treasury Bills are limited in scope and their application. The realization of some of the mentioned measures in full should provide the government with the opportunity to receive additional financial resources that can be used as collateral for the development of the country in the economical dimension (Bureau).
In view of the introduction of the MSS in 2004, the Foreign Institutional Investors initiated activity aimed to purchase Indian stocks in the American national currency. As the result of such situation, the financial market of India encountered unprecedented flow of the American currency to the domestic market. In order to prevent decrease of the value of the local currency, the RBI decided to purchase dollars for the return of the national currency to the same market. However, this approach failed and resulted in the appearance of the increased rates of the liquidity in the Indian financial market. With that, the MSS presumes that the increased level of the liquidity can be tackled with the provision of several government securities. The collected financial resources are placed at the banking account of the Market Stabilization Scheme Account that should ensure financial stability of the Indian market. The introduction of the MSS became the first step in the desire of the RBI to stabilize the market. However, the next step pertains to the introduction of the governmental bonds and securities that can be purchased by any individual or company in the country. Besides, there are high chances in the creation of the situation where the commercial banks will lack financial resources because of their storage in form of the governmental bonds. In this regard, the reduction of the liquidity of the national currency will be achieved while these resources will return to the RBI as the direct holder of the reserve. From this perspective, it is possible to state that the actions of the RBI are reasonably justified in reference to the stabilization of the financial market. In this respect, the only viable tool that was envisaged by the MSS at the stage of the introduction is referred to the establishment of certain ceiling on CRR. With that, the cash reserve ratio should be accepted as certain volume or percentage of the overall amount of the deposits that are requested by the central financial institution. Hence, the cash reserve ratio can perform the functions of the contingency banking account as the commercial bank does not receive any interest because of the maintenance of this account. Despite the fact that the financial theory implies possible application of several other measures preceding the reduction of the liquidity, the RBI decided to stand to the CRR as the most credible one ("5 Things You Must Know About Rbis Market Stabilisation Scheme").
In December 2016, the RBI reconsidered its measures and policy aimed to stabilize the financial system. At the end of this observation, the central bank of India came to the conclusion that it is necessary to increase MSS bonds ceiling to 6 million on Indian national currency. For the confirmation of this approach, the leadership of the RBI stated on the necessity to withdraw 100% case reserve ration against the existing deposits that have been collected within certain period of time as the temporary ban on the reduction of the significant liquidity in the financial market of India. Although, this approach is not transparent for the other financial institutions in the market as the attitude to the CRR is not clear enough. This implies that the RBI is now responsible over the viability of the commercial banks due to the fact that its maintenance affects the entire profitability of these banks. Absence of the CRR measure will create obstacles to the performance of the commercial banks in the market as these institutions will lack capabilities to receive profit on the CRR (Nair). Therefore, the RBI should reconsider its market stabilization scheme in terms of the measures resulting in the increasing profitability of the commercial banks because of the interest rates under the CRR measure.
The presentation of the amendments to the current stabilization strategy of the RBI grounds on the desire of the central bank of India to limit proliferation of the liquidity within the financial system of the country. However, this institution failed to address the effects of the ban on creation of 500 and 1,000 rupee notes that contributed to the expansion of the liquidity within the financial system. The ongoing development of the liquidity confirms that the Reserve Bank of India lacks understanding of the situation in the financial market of the country. In fact, the central financial institution has achieved certain progress in the stabilization of the financial system with partial removal of the excessive liquidity. Although, the level of this negative effect is still significant in order to cause damages to the operation and viability of the commercial financial institutions. At the same time, it is predictable that the RBI will have to find additional measures with the purpose to absorb current liquidity in the financial market in favour of the stabilization of the activity of the other participants of the financial system ("India Raises Market Stabilisation Bond Issuance Limit, RBI Says"). Therefore, the Reserve Bank of India borrows financial resources form the domestic market in order to allocate these funds in the relevant industries. In fact, this approach will ensure small reduction of the liquidity while the effect of the increased ceilings on the MSS are not assessed by the managers of the RBI. This implies that the viability of the commercial banks is not taken as the primary concern for the RBI as the central financial institution takes care of the stability of the system and purchase of the American national currency. However, the interests of the commercial banks should be observed now even with the introduction of the recent changes to the MSS. The evaluation of the needs and interests of the commercial banks will result in the situation where these companies will contribute to the development and operation of the domestic financial market.
Conclusion
The new stage in the maintenance of the stability and proper functioning of the system in India was launched in 2004 with introduction of the MSS. More than 10 years passed while the Reserve Bank of India can not claim significant developments and achievements in the limitation of the excessive liquidity in the domestic market. However, the RBI acts sustainably in creation and application of the measures pursuing the achievement of the stabilization of the financial market. This approach is advantageous for the RBI because of the receipt of the additional financial resources that are allocated at the additional banking account created under the MSS. Although, the recent introduction of the raise of bond ceilings under the MSS reaffirms that the RBI is in need for the external assistance for the creation of the amended stabilization policy and strategies. In fact, the activity of the central bank is different from the performance of the commercial financial institutions. In this respect, the central bank should recognize that the supervision of the activity of the commercial banks should be in place. Hence, the existing CRR should be promoted and supported further by the RBI in order to grant access to the commercial banks to receipt revenue from the interest rates on the usage of CRR measure. Moreover, it is more than recommended for the RBI to look for the additional instruments and tools that will contribute to the viability of the commercial financial institutions. Therefore, it should be noted that the current market stabilization scheme of the Reserve Bank of India is important for the maintenance of the stability of the financial market of the country. Besides, this stability should be achieved with the adoption of the updated version of this policy where the interests and needs of all parties including the commercial financial institutions will be taken into account. The financial system of any country represents interdependent connections so that the activity of one institution will have direct effect over the state of the other organization. Therefore, absence of the stability in the performance of the commercial banks will lead to the instability of the financial system as the whole.
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