__________________________

ARTICLE REVIEW
REPORT
On
“Effect of Changes in Monetary Policy
on the Performance of NBFC's”

Submitted By:
Anusuya Sarkar
Ritesh Jha
 Sarika Joshi

MONETARY POLICY

Monetary policy is the management of money supply and interest rates by

central banks to influence prices and employment. Monetary policy works
through expansion or contraction of investment and consumption
expenditure.

Monetary policy is the process by which the government, central bank

(RBI in India), or monetary authority of a country controls
(i) the supply of money
(ii) availability of money
(iii) cost of money or rate of interest , in order 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 is referred to as either being an expansionary policy, or a

contractionary policy, where an expansionary policy increases the total
supply of money in the economy, and a contractionary policy decreases the
total money supply. Expansionary policy is traditionally used to combat
unemployment in a recession by lowering interest rates, while
contractionary policy involves raising interest rates in order to combat
inflation. Monetary policy is contrasted with fiscal policy, which refers to
government borrowing, spending and taxation
OBJECTIVES OF MONETARY POLICY
The following are the main objectives of RBI's monetary policy:-

1) GROWTH WITH STABILITY:

 The monetary policy aims at economic growth through price stability

and provision of adequate credit to productive sectors of the
economy to support aggregate demand so as to ensure high GDP
growth.
 This growth with stability through controlled expansion of credit.
 CRR, SLR and Repo Rate have their effects on the banking
transaction of various sectors of the economy that brings about
economic growth of the nation.

2) FINANCIAL STABILITY :

 Financial stability is the ability of an economy to absorb and

overcome shocks in the financial system.
 These shocks (Internal/External) can destabilize the financial system
and cause volatile and unpredictable change in the economy.
 Therefore the monetary policy of the RBI has laid a great emphasis
to maintain confidence in the financial system through proper
regulations, supervision and adequate development of the financial
system.

3) FINANCIAL INCLUSION :

 Financial inclusion is the process by which financial services and

timely and adequate credit at affordable costs are provided to the
weaker section and the low income groups.
 Therefore the RBI along with NABARD is focusing on micro
financing to reduce income inequality in the economy.

4) INFLATION CONTROL :

 Through inflation control is obstructive to economic growth, over

inflation has an adverse effect on the economy. So the RBI has to
balance economic growth with inflation.
 Inflation can be controlled by increasing the CRR that results in high
interest rates and greater saving.
 This reduces demand for goods and services that helps in controlling
inflation.

5) EMPLOYMENT GENERATION :

 Monetary policy promotes economic growth that increases the

provision of credit to various sectors of the economy. This leads to
expansion of business activities that naturally leads to employment
generation.
 Micro financing promotes the generation of self employment that
further enhances the economic growth of a nation.

6) EXTERNAL STABILITY:

 IN recent years import and exports of our country have grown

significantly and so has the two way movement of financial flows.
 This may lead to exchange rate instability and inflation.
 The RBI can control such situation by adopting selective credit
control measures and buying and selling foreign currencies in the
open market.

7) SAVING AND INVESTMENT:

 Through effective monetary management, the RBI influences and
encourages people to increase savings
 Differential interest rates offering attractive interests promotes
savings and investments in the economy.

8) HEALTHY COMPETITION:

 The monetary policy has induced healthy competition in the banking

sector in India.
 Transparency in banking transactions and professionalism also
results in improved efficiency of banking sector in India.

9) REDUCES SPECULATIVE ACTIVITIES:

 The RBI fixes the ceiling limit of credit that

controls lending/advances by banks in certain controlled
commodities or securities.
 This reduces the speculative activities in the stock markets and
commodity markets.

10) REGULATION OF NON–BANKING FINANCIAL

INSTITUTION:

 Non – banking financial institution like UTI, LIC, IFCI etc plays a
crucial role in the deployment of credit and mobilization of savings.
 Though the RBI has no direct control over these institutions, its
monetary policy influences the general interest rates in the entire
economy.
 This indirectly affects the operational policies of the NBFIs.
 INTRODUCTION OF NBFC:
Non Banking Financial Companies (NBFCs) in India were having
golden days during 1990s. Their heady days were fueled with the
rapid industrial growth due to liberalization in 1991, simple
resource-raising regulations and eager & greedy investors ready to
put their saving into any finance company. As has been said, when
you have ample amount of something you do not care for it,
NBFCs too have invested heavily but unwisely. Growth-at- any-
cost was the strategies of some of the NBFCs. Moreover, due to
this many weak NBFCs could not pay the hefty interest during the
industrial slowdown during 1997 bringing to an end the golden
period (or otherwise) of NBFCs.

The rating agencies downgraded many companies which was

followed by the RBI tightening the resource raising and prudential
norms in January 1998. Below I will mention the recent
regulations to which a NBFC has to adher to:

 Minimum net owned fund of Rs.100 crore;

 The company should have made net profit as per last two
years audited balance sheet;
 The percentage of net NPAs to net advances of the NBFC as
per the last audited balance sheet should not be more than 3%;
 The non-deposit-taking NBFCs (NBFCs-ND) should have
CRAR of 10% and deposit-taking NBFCs (NBFCs-D) should
have CRAR of 12% or 15%, as applicable to the company.

As recognized by RBI the specific roles of NBFCs' are:

 Development of sectors like Transport & Infrastructure
 Substantial employment generation
 Help & increase wealth creation
 Broad base economic development
 Irreplaceable supplement to bank credit in rural segments
 major thrust on semi-urban, rural areas & first time buyers /
users
 To finance economically weaker sections
 Huge contribution to the State exchequer
 Why there is a demand for NBFCs';
 NBFCs provide prompt, tailor made service with least
hassles. This more than compensates for the higher lending rates
of NBFCs as compared to Banks & FIs
 All customers get direct and easy access to and individual
attention of the top management
 NBFCs cater to a class of borrowers who: -
     - Do not necessarily have a high income
     - But have adequate net worth
     - Are honest and sincere (gauged by the personal touch
maintained with them).
 Deposit mobilization at the doorstep of the depositors with
personalized approach, interest warrants are delivered in advance
 NBFCs provide financial assistance to their borrowers in case
of emergency needs
 NBFCs provide assistance and guidance to their customers in
matters relating to insurance
REVIEW ARTICLE
Indian Budget: Microfinance fund allocation
doubled to INR 4,000M
By Nagesh Narayana

Microfinance Focus, Feb 26, 2010 : Presenting the Union

Budget 2010-11 to parliament on Friday, India’s Finance Minister
has reiterated the UPA government’s commitment to expanding
financial inclusion and expanding the microfinance programmes,
by doubling allocation to Micro-Finance Development and Equity
Fund to Rs. 400 crore (INR 4,000 million).
He has also increased allocation by Rs 100 crore (INR 1,000
million) each to the Financial Inclusion Fund (FIF) and the
Financial Inclusion Technology Fund — the two major
microfinance funds created by NABARD to lend to SHGs.
Another key focus in the budget is to provide banking to majority
of rural people through the Business Correspondent model and
extend the model’s coverage of products to insurance and other
services.
Lead Bank Scheme :
Targeting the ‘Aam Aadmi’, the budget referred to the High Level
Committee on the Lead Bank Scheme that was crucial to Business
Correspondent model to reach the unbanked rural people and
extend microfinance services. While operational modalities were
not spelt out, the programme seeks to provide appropriate banking
facilities to habitations with more than 2,000 populations.
Another significant feature is setting a deadline, i.e., March 2012.
While the deadline is not realistic, it denotes the seriousness to
carry out financial inclusion drive. Secondly, it seeks to extend to
other products like insurance and other services, which has long
been the demand of the microfinance institutions. The target that
the budget has set is to cover 60,000 habitations. With the RBI’s
recent modifications in the proposed Business Correspondent
model facilitating non-SHG microfinance institutions, this is
possible but the industry’s demand to make it more liberal is yet to
be answered.
Rural Employment :
Apparently, the finance minister is not inclined to have given
enough allocation to NREGA, the much-talked-about rural
employment guarantee programme. Renamed Mahatma Gandhi
National Rural Employment Guarantee Scheme, NREGA has
completed four years of implementation during which it has been
extended to all districts covering more than 45 million households.
Last year, Pranab Mukherjee allocated Rs.39,100 crore (INR
391,000 million) in his 2009-10 budget, marking an increase of
144% over 2008-09 budget. Surprisingly, in 2010-11 budget, the
figure has been rounded off to nearest figure at Rs.40,100 crore
(INR 401,000 million) and no explanation has gone into the
budget for this static figure. It certainly indicates that the
government seeks to cap the rural employment programme at this
level. Otherwise, those who have worked for more than 15 days
during the preceding financial year under the NREGA have been
extended the Rashtriya Swasthya Bima Yojana (insurance cover)
under the budget which will benefit the below poverty line
workers and their families in rural areas.
Financial Inclusion & Microfinance :
The microfinance programme this year received a boost in terms
of more allocation to the twin-funds managed by NABARD for
financial inclusion. Set up in 2007-08 the Financial Inclusion
Fund and the Financial Inclusion Technology Fund, have been key
in government’s actions programme to achieve financial inclusion.
With an additional Rs.100 crore (INR 1,000 million) for each of
these funds, the government has cleared the decks for functional
phase of ensuing Business Correspondent model in rural areas.
In addition, the programme for linking Self Help Groups (SHGs)
with the banking system, re-designated as the ‘Micro-Finance
Development and Equity Fund’ in 2005-06 with a corpus of
Rs.200 crore (INR 2,000 million) has seen doubling of allocation
to Rs. 400 crore (INR 4,000 million) in the current budget. A
positive development indeed but the focus is likely to be in the
north eastern and eastern region, where many anti-poverty
programmes have yielded little result in terms of improving the
financial access norms to the poor and rural households.
Access to banking services :
One important point that the finance minister made in his opening
remarks was to ensure the growth of banking system to meet the
needs of a modern economy, expansion in geographic terms and
improve access to banking services. While the RBI is considering
giving some additional banking licences to private sector players,
Non Banking Financial Companies (NBFCs) could also be
considered, if they meet the RBI’s eligibility criteria. While this
addresses the long-time demand of NBFCs to raise deposits from
the members, it is unlikely to help the microfinance sector’s
emerging MFI-NBFCs which have been seeking similar privilege.

Unique Identification Authority :

Allocation of Rs 1,900 crore (INR 19,000 million) to the Unique
Identification Authority of India as it enters into its operational
phase and begin issuing UIDs next year, a long-term goal to
achieve financial access for the poor and rural households will
become a reality in near future.