Financial Reforms Including Financial Inclusion Commerce YouTube Lecture Handouts

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Title: Financial Reforms Including Financial Inclusion

Financial Reforms Including Financial Inclusion

Financial Sector Reforms: The Approach

  • The initiation of financial reforms in the country during the early 1990s was to a large extent conditioned by the analysis and recommendations of various Committees/Working Groups set-up to address specific issues.
  • Reform measures introduced across sectors as well as within each sector were planned in such a way so as to reinforce each other.
  • Attempts were made to simultaneously strengthen the institutional framework while enhancing the scope for commercial decision making and market forces in an increasingly competitive framework.
  • The major aim of the reforms in the early phase of reforms, known as first generation of reforms, was to create an efficient, productive and profitable financial service industry operating within the environment of operating flexibility and functional autonomy.
  • The focus of the second phase of financial sector reforms starting from the second-half of the 1990s, has been the strengthening of the financial system and introduction of structural improvements.
  • As pointed out by Governor Reddy (Reddy, 2002) , the approach towards financial sector reforms in India is based on panchasutra or five principles:
    • Cautious and appropriate sequencing of reform measures.
    • Introduction of norms that are mutually reinforcing.
    • Introduction of complementary reforms across sectors (most importantly, monetary, fiscal and external sector) .
    • Development of financial institutions
    • Development of financial markets

Objectives

  • The main objectives, therefore, of the financial sector reform process in India initiated in the early 1990s have been to:
    • Promote the maintenance of financial stability even in the face of domestic and external shocks.
      • Remove financial repression that existed earlier;
      • Create an efficient, productive and profitable financial sector industry;
      • Enable price discovery, particularly, by the market determination of interest rates that then helps in efficient allocation of resources;
    • Prepare the financial system for increasing international competition;
      • Provide operational and functional autonomy to institutions;
      • Open the external sector in a calibrated fashion;

Financial Sector Reforms

  • Reforms in the Government Securities Market Institutional Measures
    • Reforms in the Banking Sector
    • Reforms in the Monetary Policy Framework
  • Reforms in the Foreign Exchange Market Exchange Rate Regime

Financial Inclusion

Reforms in the Banking Sector

Reforms in the Banking Sector

Reforms in the Government Securities Market & Institutional Measures

  • Administered interest rates on government securities were replaced by an auction system for price discovery.
  • Automatic Monetisation of fiscal deficit through the issue of ad hoc Treasury Bills was phased out.
  • Primary Dealers (PD) were introduced as market makers in the government securities market.
  • For ensuring transparency in the trading of government securities, Delivery versus Payment (DvP) settlement system was introduced.
  • Increase in Instruments in the Government Securities Market: 91-day Treasury bill was introduced for managing liquidity and benchmarking.
  • Zero Coupon Bonds, Floating Rate Bonds, Capital Indexed Bonds were issued and exchange traded interest rate futures were introduced.
  • OTC interest rate derivatives like IRS/FRAs were introduced.

Enabling Measures

  • Foreign Institutional Investors (FIIs) were allowed to invest in government securities subject to certain limits.
  • Introduction of trading of government securities on stock exchanges for promoting retailing in such securities, permitting non-banks to participate in repo market.

Reforms in the Foreign Exchange Market Exchange Rate Regime

  • Evolution of exchange rate regime from a single currency fixed-exchange rate system to fixing the value of rupee against a basket of currencies and further to market-determined floating exchange rate regime.
  • Adoption of convertibility of rupee for current account transactions with acceptance of Article VIII of the Articles of Agreement of the IMF. De facto full capital account convertibility for nonresidents and calibrated liberalization of transactions undertaken for capital account purposes in the case of residents.
  • Institutional Framework - Replacement of the earlier Foreign Exchange Regulation Act (FERA) , 1973 by the market friendly Foreign Exchange Management Act, 1999.
  • Delegation of considerable powers by RBI to Authorised Dealers to release foreign exchange for a variety of purposes. Increase in Instruments in the Foreign Exchange Market
    • Development of rupee-foreign currency swap market.
    • Development of rupee-foreign currency swap market.
  • Authorised dealers permitted to use innovative products like cross currency options, interest rate, currency swaps, caps/collars and forward rate agreements (FRAs) in the international forex market.
  • Liberalization Measures
    • Authorised dealers permitted to initiate trading positions, borrow and invest in overseas market subject to certain specifications and ratification by respective Banks՚ Boards.
    • FIIs and NRIs permitted to trade in exchange-traded derivative contracts subject to certain conditions.
  • Move from direct instruments (such as, administered interest rates, reserve requirements, selective credit control) to indirect instruments (such as, open market operations, purchase and repurchase of government securities) for the conduct of monetary policy.
  • Use of open market operations to deal with overall market liquidity situation especially those emanating from capital flows.
  • Introduction of Liquidity Adjustment Facility (LAF) , which operates through repo and reverse repo auctions to set up a corridor for short-term interest rate.
  • LAF has emerged as the tool for both liquidity management and also as a signalling device for interest rate in the overnight market.
  • Introduction of Market Stabilization Scheme (MSS) as an additional instrument to deal with capital inflows without affecting short-term liquidity management role of LAF.
  • Development of pure inter-bank call money market. Non-bank participants to participate in other money market instruments.
  • Introduction of automated screen-based trading in government securities through Negotiated Dealing System (NDS) .
  • Setting up of risk-free payments and system in government securities through Clearing Corporation of India Limited (CCIL) .
  • Phased introduction of Real Time Gross Settlement (RTGS) System.

MCQs

(1) Foreign Exchange Regulation Act (FERA) , 1973 was replaced by the market friendly ________Act.

Answer: Foreign Exchange Management Act, 1999

(2) Introduction of ________ which operates through repo and reverse repo auctions to set up a corridor for short-term interest rate.

Answer: Liquidity Adjustment Facility (LAF) ,

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