Financial System- Pre And Post Liberalization Reforms


1. Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system. Commercial banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 3% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly basis and the RBI is empowered to increase the rate of CRR to such higher rate not exceeding 20% of the NDTL.

2. Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest. An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system.

 3. Repo rate. The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI. A reduction in the repo rate helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US.

4.The Monopolies and Restrictive Trade Practices Act, 1969, aims to prevent concentration of economic power to the common detriment, provide for control of monopolies and probation of monopolistic, restrictive and unfair trade practice, and protect consumer interest.

Monopolistic trade practice is that which represents abuse of market power in the production and marketing of goods and services by eliminating potential competitors from market and taking advantage of the control over the market by charging unreasonably high prices, preventing or reducing competition, limiting technical development, deteriorating product quality or by adopting unfair or deceptive trade practices.

5. The Foreign Exchange Regulation Act (FERA) was legislation passed by the Indian Parliament in 1973 by the government of Indira Gandhi and came into force with effect from January 1, 1974. FERA imposed stringent regulations on certain kinds of payments, the dealings in foreign exchange and securities and the transactions which had an indirect impact on the foreign exchange and the import and export of currency.[1] The bill was formulated with the aim of regulating payments and foreign exchange.[2]

6.The Foreign Exchange Management Act(FEMA) was an act passed in the winter session of Parliament in 1999 which replaced Foreign Exchange Regulation Act. This act seeks to make offenses related to foreign exchange civil offenses. It extends to the whole of India.

FEMA, which replaced Foreign Exchange Regulation Act (FERA), had become the need of the hour since FERA had become incompatible with the pro-liberalization policies of the Government of India. FEMA has brought a new management regime of Foreign Exchange consistent with the emerging framework of the World Trade Organization (WTO). It is another matter that the enactment of FEMA also brought with it the Prevention of Money Laundering Act 2002, which came into effect from 1 July 2005.

7. Prime lending rate. The interest rate that commercial banks charge their best, most credit-worthy customers. Generally a bank’s best customers consist of large corporations. The rate is determined by the Federal Reserve’s decision to raise or lower prevailing interest rates for short-term borrowing. Though some banks charge their best customers more and some less than the official prime rate, the rate tends to become standard across the banking industry when a major bank moves its prime up or down. The rate is a key interest rate, since loans to less-creditworthy customers are often tied to the prime rate. For example, a Blue Chip company may borrow at a prime rate of 5%, but a less-well-established small business may borrow from the same bank at prime plus 2, or 7%. Many consumer loans, such as home equity, automobile, mortgage, and credit card loans, are tied to the prime rate. Although the major bank prime rate is the definitive “best rate” reference point, many banks, particularly those in outlying regions, have a two-tier system, whereby smaller companies of top credit standing may borrow at an even lower rate.

8. The BPLR is the interest rate that commercial banks charge their most credit-worthy customers. According to the Reserve Bank of India banks are free to fix the Benchmark Prime Lending Rate (BPLR) with the approval of their respective Boards. Banks are free to decide the BPLR but their interest rates have to have a reference to the BPLR fixed.

 9. Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets. They can also include operating companies which decide to invest their profits to some degree in these types of assets.It includes banks,insurance companies mutual funds.

10. The Base Rate is the minimum interest rate of a Bank below which it cannot lend, except for DRI advances, loans to bank’s own employees and loan to banks’ depositors against their own deposits. (I.e. cases allowed by RBI).

11.Statutory Liquidity Ratio-This term is used by bankers and indicates  the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities.  Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) It regulates the credit growth in India

12. Exchange Rate Regime:- An exchange-rate regime is the way an authority manages its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors. The basic types are a floating exchange rate, where the market dictates movements in the exchange rate; a pegged float, where a central bank keeps the rate from deviating too far from a target band or value; and a fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro or a basket of currencies.

13.  Deregulation Of Interest Rate :-  During the economics reforms period, interest rates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit of interest on deposits. Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs. Interest rates on the bank loans above Rs.2 lakhs are full decontrolled. These measures have resulted in more freedom to commercial banks in interest rate regime.

14. Fixing Prudential Norms:- In order to induce professionalism in its operations, the RBI fixed prudential norms for commercial banks. It includes recognition of income sources. Classification of assets, provisions for bad debts, maintaining international standards in accounting practices, etc. It helped banks in reducing and restructuring Non-performing assets (NPAs).

15. CRAR:- Capital adequacy ratio (CAR), also called Capital to Risk (Weighted) Assets Ratio (CRAR), is a ratio of a bank’s capital to its risk. National regulators track a bank’s CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements.

16. Operational Autonomy :- During the reforms period commercial banks enjoyed the operational freedom. If a bank satisfies the CAR then it gets freedom in opening new branches, upgrading the extension counters, closing down existing branches and they get liberal lending norms.

17. Fiscal Monetary Separation:- In 1994, the Government and the RBI signed an agreement through which the RBI has stopped financing the deficit in the government budget. Thus it has separated the Monetary policy from the fiscal policy.

18. Changed Interest Rate Structure  : During the 1990s, the interest rate structure was changed from its earlier administrated rates to the market oriented or liberal rate of interest. Interest rate slabs are now reduced up to 2 and minimum lending rates are abolished. Similarly, lending rates above Rs. Two lakh are freed.

 19. Working Capital Management: - Working capital management was more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to their customers.

20. Forward Premium On Indian Rupee:- It reflects the market’s beliefs about the future changes in its value.

 21. CIP:- Covered Interest Parity condition gives us the measure of India’s integration with global markets. The CIP is no arbitrage relationship that ensures that one cannot borrow in a country, convert to and lend in another currency, insure the returns in the original currency by selling his anticipated proceeds in the forward market and make profits without risk through this process.

22. Dynamics Of Swelling Reserves:- An important corollary of India’s foreign exchange policy has been the quick and significant accumulation of foreign currency reserves in the past few years. A sizable foreign exchange reserve acts as liquidity cover and protects against a run on the country’s currency, and reduces the rate of interest on Indian debt in the world market by lowering the country risk perception by international rating agencies.

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Mufaddal Dahodwala

The author is ex-employee of Accenture and he is currently pursuing MMS finance from JBIMS,mumbai. He has won several prizes from top MNCs for his contribution towards articles as well as idea generation and business plans having a social impact to the society.

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