CHAPTER-2 : MONETARY MANAGEMENT AND FINANCIAL INTERMEDIATION: STABILITY IS THE WATCHWORD

Economy Survey 2023-2024 : Revision Notes

Introduction

Indian Economy: Financial Overview

• Strong performance despite geopolitical challenges.
• Central bank maintained steady policy rate, inflation under control.
• Monetary tightening post Russia-Ukraine conflict increased lending and deposit rates.
• Bank loans grew significantly, personal and services loans led.
• Stock market capitalization ranked 5th globally.
• Digital Public Infrastructure (DPI) improved financial inclusion.
• Insurance and pension sectors expanded coverage.

Chapter Focus:

• Monetary developments: Economy’s monetary and liquidity conditions.
• Financial intermediation: State of financial institutions and market instruments.

Financial Intermediation:

• Banking sector: Core of financial intermediation.
• Insolvency and Bankruptcy Code (IBC): Game-changer for distressed assets.
• Financial inclusion: Emphasis on digital inclusion and data protection.
• Microfinance institutions (MFIs): Facilitating financial inclusion.
• Securities markets: Efficient resource mobilization, global stature.
• IFSC GIFT City: Emerging global financial and IT hub.
• Insurance and pension sectors: Growth and expansion.
• Financial Stability and Development Council (FSDC): Regulatory coordination.

Overall Outlook:

• Positive outlook with challenges ahead.

MONETARY DEVELOPMENTS

Basic

Monetary Policy Tools

Think of a bank as a water tank. The central bank, like a water regulator, controls how much water (money) can flow in and out of the tank.

• CRR (Cash Reserve Ratio): This is like the bank having to keep a bucket of water from the tank always filled. The central bank decides how full the bucket should be. If the bucket is bigger, the bank has less water to lend out, which can slow down the economy.
• SLR (Statutory Liquidity Ratio): Similar to the CRR, but instead of keeping water in a bucket, the bank has to use some water to buy government bonds (like saving for a rainy day). Again, more water used for bonds means less to lend out.
• Open Market Operations (OMO): Imagine the central bank as a water supplier. If it wants to increase the water level in the tank (inject money), it sells government bonds to banks. If it wants to decrease the water level (absorb money), it buys back those bonds.
• Credit Ceilings: This is like setting a limit on how much water the bank can give out to each customer. The central bank can tighten or loosen these limits to control how much money is flowing in the economy.

By using these tools, the central bank can influence interest rates, inflation, and economic growth.

1.Monetary and Credit Conditions

Monetary Policy Stance

• Repo rate maintained at 6.5% in FY24.
• Focus on withdrawing liquidity to control inflation while supporting growth.
• Cumulative rate hike of 250 bps since May 2022.

Factors Affecting Monetary Conditions

• Withdrawal of ₹2000 banknotes.
• Merger of HDFC and HDFC Bank.
• Temporary imposition of I-CRR.

Monetary Aggregates

• Return of ₹2000 banknotes led to deposit growth and M3 expansion.
• CiC growth moderated due to ₹2000 banknotes withdrawal.
• Reserve money (M0) growth slowed down.
• Broad money (M3) growth accelerated due to deposit growth and bank credit.
• Money multiplier increased.

Key Drivers

• Net foreign assets drove M0 growth.
• Bank credit to commercial sector was the main driver of M3 growth.

Basic

1. M0 to M4 in the Indian Economy

M0 to M4 are monetary aggregates, representing different measures of money supply in an economy.

• M0: This is the narrowest measure and represents the most liquid form of money. It includes currency in circulation (coins and banknotes) and demand deposits held by commercial banks with the central bank (Reserve Bank of India).
• M1: This is slightly broader than M0 and includes M0 plus demand deposits held by the public with commercial banks. It represents money that can be used for transactions immediately.
• M2: This is a broader measure, encompassing M1 plus savings deposits with post office savings banks and ‘other deposits’ with the Reserve Bank of India.
• M3: This is the most commonly used measure of money supply and includes M2 plus time deposits with commercial banks, deposits with post office savings banks, and net inter-bank deposits.
• M4: This is the broadest measure and includes M3 plus total deposits with post office savings banks and deposits with other financial institutions.

These monetary aggregates provide insights into the liquidity in the economy, which influences factors like inflation, interest rates, and economic growth. The Reserve Bank of India (RBI) closely monitors these figures to formulate monetary policy.

Essentially, as we move from M0 to M4, the liquidity of money decreases, and the time required to convert it into cash for transactions increases.

2.Liquidity conditions and trends in policy rates

RBI’s Liquidity Management

• Used Variable Rate Reverse Repo (VRRR) and Variable Rate Repo (VRR) auctions to manage liquidity.
• Employed fine-tuning operations (VRRR & VRR) for adjustments.
• Introduced MSF for banks with surplus funds.
• Allowed reversal of SDF and MSF funds during weekends and holidays.

Liquidity Conditions

• Excess liquidity due to ₹2000 banknotes return led to I-CRR imposition.
• I-CRR temporarily absorbed liquidity.
• Liquidity conditions turned deficit after I-CRR removal.

FINANCIAL INTERMEDIATION

Basic

1.Capital Adequacy Ratio (CAR)

The Capital Adequacy Ratio (CAR) is a financial metric that measures a bank’s ability to absorb losses without going bankrupt. It’s calculated by dividing a bank’s total capital by its risk-weighted assets. A higher CAR indicates a healthier financial position.

How is CAR calculated?

CAR = (Tier 1 capital + Tier 2 capital) / Risk-weighted assets

• Tier 1 capital is the core capital, comprising equity, retained earnings, and reserves. It’s the primary buffer against losses.
• Tier 2 capital is supplementary capital, including undisclosed reserves, hybrid capital instruments, and subordinated debt. It offers additional protection but is less reliable than Tier 1 capital.
• Risk-weighted assets are a bank’s assets assigned weights based on their associated risk. Higher-risk assets have higher weights.

Why is CAR important?

• Protects depositors: A strong CAR ensures a bank can repay depositors even during financial crises.
• Maintains financial stability: Adequate capital prevents bank failures, which can destabilize the entire economy.
• Risk management: CAR encourages banks to assess and manage risks effectively.

CAR and Regulatory Requirements

Central banks and regulatory authorities set minimum CAR requirements to safeguard the banking system. Banks must maintain capital above this threshold to operate. A higher CAR than the minimum is generally seen as a positive indicator of a bank’s financial health.

Back into Economy Survey

1.Performance of the banking sector and credit availability

Banking Sector Performance

• Improved asset quality, provisioning, capital adequacy, and profitability.
• Robust credit growth, led by services and personal loans.
• Deposit growth accelerated due to rate hikes and term deposit repricing.
• NBFC lending increased, driven by personal loans and industry loans.
• Asset quality of NBFCs improved.

Bank Credit Growth

• FY24 credit disbursal: ₹3 lakh crore (20.2% YoY growth).
• Continued growth in FY25 (19% and 19.8% in April and May).

Sectoral Credit Growth

• Agriculture:
  • Double-digit growth in FY24.
  • Increased from ₹3 lakh crore in FY21 to ₹20.7 lakh crore in FY24.
  • KCC scheme with 7.4 crore operative accounts.
  • Continued growth in April and May 2024 (19.7% and 21.6% YoY).
• Industry:
  • Picked up in H2 FY24 (8.5% growth).
  • Boost to MSMEs through ECLGS and digital lending.
  • OCEN expected to boost credit flow to MSMEs.
• Services:
  • Resilient despite NBFC slowdown.
  • Growth in commercial real estate and trade.
  • Personal loans and NBFCs have largest share.
  • Housing loan growth improved in April and May 2024.
• Personal loans:
  • Significant growth due to digitalization.
  • Moderated after December 2023 due to increased capital requirements.

Key Figures

• Housing loan disbursal increased from ₹19.9 lakh crore to ₹27.2 lakh crore.
• KCC operative accounts: 7.4 crore.

Improvement in Asset Quality of Banks

• Improved asset quality due to:
  • Better borrower selection
  • Effective debt recovery
  • Increased debt awareness among large borrowers
  • Enhanced disclosures, code of conduct, and governance
• GNPA ratio:
  • Decreased to 2.8% in March 2024 from 11.2% in FY18.
  • Agriculture sector GNPA remains high at 6.5%.
  • Improvement in personal loans and most industrial sub-sectors.
• Net NPAs declined due to lower GNPAs and high provisions.
• Capital adequacy:
  • CRAR increased to 16.8% in March 2024.
  • All banks met CET-1 ratio requirement.
• Profitability:
  • NIM remained robust at 3.6%.
  • Profit after tax rose by 32.5% YoY.
  • RoE and RoA reached decadal highs.
• Cost of funds increased by 100 basis points, yield on assets by 75 basis points.
• NIM peaked at 3.9% in Q1 FY24, moderated to 3.6% in March 2024.
• Banking sector resilience:
  • RBI and government measures enhanced risk absorption capacity.
  • 9% of deposits with PSBs.
  • 1% of deposits owned by households.
  • Top 10 banks have loans as 50% of total assets.
  • Improved CRAR for top 10 SCBs.
  • Experience with interest rate cycles.
• Conclusion:
  • Indian banking system sound and resilient.
  • High capital adequacy, improved asset quality, robust earnings growth.
  • Profitability improvement continued for fifth consecutive year.

Improving Credit Flow to MSME Sector

Government Initiatives

• Trade Receivables Discounting System (TReDS):
  • Digital platform for discounting MSME trade receivables.
  • 9 lakh invoices worth ₹2.9 lakh crore discounted as of March 2024.
• MSME Definition Change:
  • Composite criterion of turnover and investment.
  • Increased formal sector access for MSMEs.
• Udyam Registration Portal (URP):
  • Free, simple, online registration for MSMEs.
  • Facilitates credit flow at subsidized rates.
  • Challenge: Registration of Informal Micro Enterprises (IMEs).
• Udyam Assist Platform (UAP):
  • Onboarding of IMEs for formalization and access to benefits.
  • 86 crore IMEs onboarded as of June 2024.
  • Total registrations on URP and UAP: 4.5 crore.
• Revamped Credit Guarantee Scheme (CGS):
  • Additional credit of ₹2 lakh crore for MSEs.
  • ₹9,000 crore infusion in Credit Guarantee Fund Trust.
  • Credit limit increased from ₹2 crore to ₹5 crore.
  • Lower guarantee fee of 0.37% per annum.
  • ₹3 lakh crore guarantees approved in FY23 and FY24.
  • Focus on women and SC/ST enterprises.
  • Special provision for IMEs on UAP with credit up to ₹20 lakh

2. Dealing with distressed asset

Basic

Non-Performing Assets (NPAs): A Challenge for Indian Banking

Understanding NPAs

A Non-Performing Asset (NPA) is essentially a loan or advance where the principal or interest payment has been overdue for a specified period, typically 90 days. Unlike bank fraud, which is a criminal offense, NPAs are a civil issue arising from the borrower’s inability to repay the loan.

The Rise of NPAs in India

India experienced a surge in NPAs during the mid-2000s. Several factors contributed to this crisis:

• Aggressive Lending: The period between 2004 and 2009 was marked by rapid economic growth, which encouraged banks to lend aggressively to various sectors.
• Infrastructure Focus: A significant portion of these loans was directed towards infrastructure projects like roads, power, aviation, and steel.
• Lax Lending Standards: Many banks relaxed lending norms, often overlooking the borrower’s financial health and creditworthiness.
• Economic Shocks: External factors like the ban on certain mining projects and delays in environmental clearances led to rising raw material costs and disrupted supply chains, impacting sectors like power, steel, and iron. Consequently, borrowers found it difficult to repay loans.

Classification of NPAs

NPAs are categorized based on the duration of default:

• Substandard Assets: Overdue for less than or equal to 12 months.
• Doubtful Assets: Overdue for more than 12 months.
• Loss Assets: Irrecoverable and considered worthless.

Impact of NPAs

NPAs have severe consequences for the economy:

• Reduced Lending Capacity: Banks with high NPAs have less capital available for new loans, hindering economic growth.
• Increased Interest Rates: To maintain profitability, banks may increase interest rates on loans, burdening borrowers.
• Job Losses: A decline in lending can lead to reduced investments and job creation.
• Financial Instability: A high NPA ratio can erode public confidence in the banking system.

Resolving Stress in the Banking Sector

• Ability to resolve market stress: Indicator of economic soundness and resilience.
• Banking crisis in the last decade: High NPA burden, especially in public sector banks (14.5% GNPA in March 2016).
• Twin balance sheet problem: Plateauing bank debt, increased corporate leverage, stress in industry and infrastructure.
• Government measures to address stress: Strengthened banking regulations, amended recovery laws, insolvency and bankruptcy legislation, public sector asset reconstruction company.
• GNPA reduction: Decreased to 2.8% in March 2024.
• Market stress as a sign of a dynamic economy: Need for banks and markets to handle distressed assets.
• Banking regulations as first line of defense: Monitoring, identification, and addressing stress through restructuring and rescheduling loans.
• RBI’s role: Strengthening prudential framework and updating regulations based on market needs.

Debt Recovery and Asset Reconstruction

• DRTs and SARFAESI Act: Second line of defense against stressed assets.
• Recoveries and upgrades: Contributed to 45% of GNPAs reduction in FY23.
• ARCs: Emerging as alternative investment channel for NPAs.
• SRs issuance: ARCs acquire NPAs by issuing security receipts (SRs).
• ARC participation in IBC: Allowed under certain conditions.
• GNPAs sold to ARCs: Increased from 3.2% in FY22 to 9.7% in FY23.

Market for NPAs

• Requirements for efficient market: Depth, competition, and liquidity.
• Government initiatives: Building systemic strength through bad bank and insolvency ecosystem.

SEBI Measures

• FPI investments: Allowed in debt instruments of companies undergoing resolution and SRs issued by ARCs.
• Special Situation Funds: Introduced for distressed asset market participation.
• Increased FPI investment in SRs: From ₹10,000 crore in FY22 to ₹14,482 crore in FY23.

Expected Outcomes

• Increased investment in NPAs/distressed assets.
• Higher recovery rate for banks.

Distressed Asset Resolution

NARCL and IDRCL

• Government formed National Asset Reconstruction Company Ltd. (NARCL) and India Debt Resolution Company Ltd. (IDRCL) in July 2021.
• NARCL acquires distressed assets from banks with government guarantee.
• IDRCL assists NARCL in asset resolution.
• NARCL acquired 18 accounts worth ₹92,000 crore.
• Offers on assets worth ₹25 lakh crore are in process.

Insolvency and Bankruptcy Code (IBC)

• Effective solution for twin balance sheet problem.
• Provides early resolution of financial distress.
• Insolvency professional manages the process.
• Committee of creditors makes key decisions.
• Facilitated resolution of 31,394 corporate debtors worth ₹9 lakh crore.
• ₹2 lakh crore defaults resolved at pre-admission stage.
• 4,131 CIRPs closed, 3,171 corporate debtors rescued.
• Creditors recovered 32% of claims through approved resolution plans.
• IBC is the dominant recovery route for SCBs.
• ₹3 lakh crore recovered for SCBs through IBC.
• Over 3,000 businesses revived through CIRP.
• Resolved firms witnessed significant performance improvement.
• 2,476 CIRPs ended in liquidation.
• 50 businesses rescued through liquidation.
• 9 of 12 large accounts referred by RBI resolved through IBC.
• IBC framework for financial service providers enabled resolution of DHFL, Srei.
• Government strengthened National Company Law Tribunal (NCLT) and amended regulations.

Impact and Benefits

• Improved liquidity and competition in distressed asset market.
• Reduced NPAs and freed capital for banks.
• Facilitated corporate debt resolution and business revival.
• Increased recovery for creditors.
• Enhanced market valuation of resolved firms.
• Improved employment and employee expenses for resolved firms.
• Established IBC as an indispensable component of asset recovery.
• Changed credit market landscape.

Role of IBC in Reviving Stalled Real Estate Projects

Challenges before IBC

• Consumer forums as primary redressal mechanism for homebuyers.
• Over 5,500 cases filed with National Consumer Dispute Redressal Commission in FY24.
• Minimal cases resolved through consumer forums.
• 1 lakh stalled dwelling units worth ₹4.1 lakh crore

RERA and IBC

• RERA Act of 2016 provided dedicated grievance redressal mechanism
• IBC enacted in 2016 offered another remedy.
• Over 1500 real estate companies admitted into IBC.
• 133 real estate companies resolved through IBC.
• Real estate sector posed unique challenges for IBC

Amendments and Improvements

• Insolvency Law Committee recognized peculiarities of real estate sector.  
• Homebuyers made a distinguished class of creditors.  
• Homebuyers allowed direct participation in decision-making.
• Joint application by 100 allottees or 10% allottees for insolvency initiation.  
• Resolution plans required to comply with RERA.  
• Judiciary allowed reverse CIRP and project-specific resolution plans.  

Impact and Results

• Homebuyers enabled to act as resolution applicants.  
• Successful resolution of real estate companies like Value Infracon, Ashiana Landcraft, Anudan Properties, Jaypee Infratech.
• Recovery of 98% claim value in Value Infracon case.  
• Recovery of 2.5 times liquidation value in Ashiana Landcraft and Anudan Properties cases.  
• 88% recovery for creditors in Jaypee Infratech case.
• SWAMIH Fund set up to channel investments in stalled projects.  
• 32,000+ homes delivered by SWAMIH Fund.  
• Improved balance sheets of banks due to successful resolutions.

Overall Impact

• IBC emerged as a preferred remedy for homebuyers.  
• Improved resolution outcomes for real estate projects.  
• Strengthened homebuyers’ rights and protection.  
• Revitalized the real estate sector.  
• Contributed to financial stability of the banking system.

Basic

1.Insolvency and Bankruptcy Code (IBC), 2016

About IBC

• Consolidates laws for corporate, partnership, and individual insolvency.
• Aims for time-bound resolution of insolvency.
• Insolvency: Liabilities exceed assets, unable to pay debts.
• Bankruptcy: Legal declaration of inability to pay debts.
• Amended in 2021 for efficient MSME insolvency resolution.

Objectives of IBC

• Maximize asset value.
• Promote entrepreneurship.
• Ensure timely and effective resolution.
• Balance stakeholder interests.
• Facilitate competitive market.
• Provide cross-border insolvency framework.

IBC Process

• Insolvency and Bankruptcy Board of India (IBBI): Regulatory authority.
• Adjudication: NCLT for companies, DRT for individuals.
• Initiation: By debtor or creditor upon default.
• Insolvency Professional: Manages process, provides financial information.
• Moratorium: 180-day legal action prohibition.
• Committee of Creditors (CoC): Decides on debt revival, repayment, or liquidation.
• Liquidation: If no decision in 180 days, asset sale and distribution.

Distribution of Proceeds

• Insolvency resolution costs.
• Secured creditors.
• Workers and employees.
• Unsecured creditors.

3. Financial inclusion is within reach; digital financial inclusion is the next goal

Financial Inclusion as a Development Enabler

• Key driver for economic growth, reducing inequality, and poverty eradication.
• UN’s SDG emphasizes financial inclusion as a crucial enabler.
• Academic research supports positive correlation between financial inclusion and economic growth.

India’s Progress in Financial Inclusion

• Government prioritized financial inclusion.
• Significant progress in last decade:
  • Bank account ownership increased from 35% in 2011 to 77% in 2021.
  • Improved savings and borrowing from formal sources.
  • Reduced access gap between rich and poor.
  • Narrowed gender gap in financial inclusion.
• India outperforms South Asian and global averages in some indicators.
• Traditional growth alone would have taken 47 years to reach 80% bank account penetration.

Shift in Focus and Digital Financial Services

• Focus shifted from ‘every household’ to ‘every adult’ with emphasis on account usage.
• Promotion of DBT, RuPay cards, and UPI.
• Launch of UPI123Pay and UPI Lite for feature phone users.
• Collaboration with other countries for cross-border payment systems.

RBI’s Strategy for Financial Inclusion

• Target-based approach, market development, infrastructure strengthening, innovation, technology, last-mile delivery, consumer protection, and financial literacy.
• Progress in financial inclusion achieved through this strategy.

Digital Financial Inclusion (DFI)

DFI

• Digitalization of financial services driving DFI.
• DFI involves providing cost-effective digital financial services to excluded populations.
• Essential components: digital platforms and devices.

India’s DFI Journey

• COVID-19 accelerated digitalization efforts.
• Government focused on creating digital infrastructure.
• Flagship schemes like Digital India and Make-in-India promoted DPI.
• DPIs like Aadhaar, e-KYC, UPI, DigiLocker, e-sign, etc. developed.
• India emerged as a leading fintech hub.

India Stack: The Foundation

• India Stack comprises identity, payment, and data governance layers.
• Aadhaar transformed authentication, reducing e-KYC costs.
• UPI revolutionized payments with over ₹200 lakh crore transactions in FY24.
• Data governance layer ensures data ownership and control.

Impact of DFI

• Enabled millions to access financial services.
• Facilitated payments, settlements, and fund transfers.
• Digital credit potential for inclusive growth.
• IMF research links digital financial inclusion to higher economic growth.

4. Microfinance institutions: facilitating financial inclusion

Role of Microfinance

• Providing microfinance and related services to empower the poor and marginalized to achieve social equality and empowerment.
• Playing a crucial role in meeting the credit needs of low-income households.
• Offering other financial services such as insurance, remittances, and financial literacy.
• A vital tool for promoting financial inclusion.

Microfinance Sector in India

• RBI’s regulatory framework and SROs’ code of conduct have aided sector development.
• New regulatory framework for microfinance loans brings all entities under uniform rules.
• India is the world’s second largest microfinance market after China.
• Microfinance coverage in India (SHGs and Joint Liability Groups) covers over 50% of households and 10% of the Indian population.
• In FY23, 213 MFIs operated with 25,790 branches.
• Reached over 53.2 million customers with a total loan of Rs. 1.8 lakh crore.

Regional and Demographic Profile of Microfinance

• Most microfinance is focused on rural areas.
• 74% of customers are in rural areas.
• 98% of customers are women.
• 23% of customers belong to Scheduled Castes/Scheduled Tribes.

Performance of Microfinance

• Total disbursement of Rs. 1.8 lakh crore in FY23.
• Total assets of MFIs at Rs. 1.5 lakh crore in FY23.
• Improved RoA and RoE.
• Adherence to capital adequacy norms.
• Decline in NPAs and improvement in recovery.
• 6% growth in loan disbursement under SHG-BLP.
• Improvement in RBI’s financial inclusion index.

5. Trends in indian capital markets

Indian Capital Markets in FY24

• Strong performance: Despite global challenges, Indian capital markets excelled.
• Key role in growth: Capital markets increasingly contribute to capital formation and investment.
• Primary markets: Robust, raised ₹9 lakh crore (29% of gross fixed capital formation).
  • Equity: IPOs increased 66%, amount raised by 24%.
  • Debt: Increased 12.1%, dominated by private placements.
  • Hybrid: Significant growth of 513.6%.
  • SME IPOs surged.
  • India led global IPO listings.
  • QIPs and rights issues gained popularity.
• Debt markets: Flourishing, corporate bond issuances up to ₹6 lakh crore.
  • Outstanding corporate bonds reached ₹45 lakh crore (15.5% of GDP).
• REITs and InvITs: Gained momentum, raised ₹39,024 crore.

Secondary Markets

• Global recovery: After a turbulent FY23, global markets rebounded in FY24, except China and Hong Kong.
• India’s strong performance: Nifty 50 up by 26.8% (vs -8.2% in FY23).
• Global market highlights: US, Brazil, and Japan performed exceptionally. AI-led tech surge, Nasdaq up 34%.
• India’s outperformance: Attributed to resilience, stable macro, and strong domestic investor base.
• Increased weight: India’s weight in MSCI-EM index rose to 17.7% (from 13.7%).
• Market capitalization: Surged, India ranked 5th globally.
  • Market cap to GDP ratio improved to 124% (from 77% in FY19).
  • Caution: High ratio might indicate market instability.
• Trading activity: Increased across segments (except currency derivatives).
  • Commodity derivatives up 87%, driven by energy options.

Retail Participation in Capital Market

• Retail participation surge: Direct and indirect channels (mutual funds).
• Individual investor share:9% in equity cash segment turnover (FY24).
• Demat accounts: Increased from 1,145 lakh to 1,514 lakh (FY23-FY24).
• NSE registered investors: Tripled from March 2020 to 9.2 crore (March 2024).
• Mutual fund growth: AUM increased by ₹14 lakh crore (35% YoY) to ₹4 lakh crore (FY24).
• Mutual fund folios: Increased from 14.6 crore to 17.8 crore (FY23-FY24).
• SIP accounts: Increased from ₹96 lakh crore in FY21 to ₹2 lakh crore in FY24.
• MF ownership in Indian equities: Increased from 7.7% to 9.2% (Dec 2021-Dec 2023).
• Factors driving retail participation: Technology, financial inclusion, digital infrastructure, low-cost brokerages, alternative income sources, lower returns from traditional assets.
• Investor awareness programs: SEBI’s online dispute resolution, centralised reporting for investor demise, enhanced investor protection funds.
• Retail investor growth: Increased tax IDs from 2.7 crore to 9.2 crore (FY19-FY24).
• Retail investor behavior: Interest in derivatives trading, potential for outsized gains, gambling instincts.
• Concerns: Risk of losses in derivatives trading, impact of stock correction, financialization risks.
• Need for orderly evolution: Balancing growth and stability, protecting investors, directing savings to productive investments.

Technology and Indian Capital Markets

• Capital market growth: Equity market capitalization reached ₹415 lakh crore (USD 5 trillion) in May 2024.
• Technology as a catalyst: Facilitated growth and efficiency.  
• SEBI’s goals: Market regulation, investor protection, market development.  
• Individual investors: Over 9.5 crore, owning nearly 10% of the market.  
• Technology’s role: Allocating capital, enabling investor participation, wealth creation.
• Market capitalisation: Increased over 100 times in three decades.
• Retail investor surge: India Stack, user-friendly apps, financial education.
• Investor protection: SCORES, SMARTs initiatives.
• Market development: T+1 settlement, interoperability, application supported by blocked account, NSDL-CAS.
• Business continuity: DR 45 framework, LAMA reporting, two-way portability.
• Challenges: Privacy concerns, cybersecurity risks, digital divide.
• Future focus: Addressing challenges, maximizing technology benefits for economic growth.

6.Gift IFSC: emerging as a dominant gateway for global capital inflows into india

GIFT IFSC: Key Points

• Objective: Onshore India-centric financial services & global capital gateway.
• Unique features: Non-resident zone, unified regulator (IFSCA), competitive tax regime.
• Banking sector: Assets crossed USD 60 billion, transactions exceeded USD 795 billion.
• Funds industry: 114 FMEs & 120 funds by March 2024, attracting global capital.
• Aircraft & ship leasing: 28+ lessors, 120+ aviation assets leased, Air India leasing from IFSC.
• Foreign universities: Deakin University & University of Wollongong established campuses.
• Future focus: Robust regulatory framework, single window IT system, ease of doing business.

Basic

1.What is GIFT City?

• GIFT (Gujarat International Finance Tec-City) Cityis located in Gandhinagar, Gujarat.
• It consists of a multi-service Special Economic Zone (SEZ), which houses India’s first International Financial Services Centre (IFSC) and an exclusive Domestic Tariff Area (DTA).
• GIFT city (Gujarat International Finance Tec-City) is envisaged as anintegrated hub for financial and technology services not just for India but for the world.
• IFSCA is theunified regulator for the development and regulation of financial products, financial services and financial institutions in International Financial Services Centers (IFSCs) in India.
• The social infrastructure in the city includes a school, medical facilities, a proposed hospital, GIFT City business club with indoor and outdoor sports facilities. It also includes integrated well-planned residential housing projects making GIFT City a truly “Walk to Work” City.

7.Developments in the insurance sector

Global Insurance Market

• Moderation due to economic slowdown, inflation, and rising cost of capital.
• Reserve adequacy concerns due to prolonged favorable development period.
• Delayed settlements and shift of inflation from goods to services impacting liability exposures.
• Total global insurance premiums contracted by 1.1% in real terms in 2022.
• Non-life insurance increased by 0.5% in 2022.
• Life insurance premiums contracted by 3.1% in 2022.

Indian Insurance Market

• Economic growth, expanding middle class, innovation, and regulatory support driving growth.
• Insurance penetration moderated slightly to 4% in FY23.
• Life insurance penetration declined from 3.2% to 3%.
• Non-life insurance penetration remained flat at 1%.
• Insurance density increased from USD 91 to USD 92 in FY23.
• Life premium growth estimated to slow to 4.1% in FY23.
• Non-life premium growth moderated to 7.7% in FY23.
• Health insurance grew by 11% in FY23.
• Agriculture insurance estimated to register flat growth in FY23.

Regulatory Initiatives

• Government’s mission “Insurance for all by 2047”.
• Bima Sugam, Bima Vahak, Bima Vistaar initiatives.
• Amendments to reinsurance regulations.
• Transition from rule-based to principle-based approach.
• Streamlining regulatory processes.
• Customer-friendly initiatives like CIS.
• Implementation of Risk-Based Supervisory Framework and Risk-Based Capital Framework.
• State insurance plans for last-mile delivery.

Growth Projections

• Total insurance premiums to grow by 7.1% in real terms (FY24-28).
• India to have fastest-growing insurance sector among G20 countries.
• Insurance penetration to increase from 3.8% to 4.3% by FY35.
• Life premiums to grow by 6.7% in 2024-28.
• Non-life premiums to grow by 8.3% annually in 2024-28.
• Total premiums to more than double in the next decade.

Challenges and Opportunities

• Need to improve customer service and address complaints.
• Mis-selling concerns in life insurance.
• Delayed and denied claims in non-life insurance.
• Focus on long-term growth and customer satisfaction.
• Balance between regulation and industry innovation.
• Leverage technology for efficient operations and customer service.

8. Developments in the pension sector

Challenges in Pension Systems

• Demographic changes: Falling birth rates impacting pay-as-you-go pension systems.
• Inflation impact: Eroding confidence in pension programs.
• Shift from DB to DC: Increased individual risk on investment returns, inflation, and longevity.
• Inclusion challenge: Gig workers and informal labor market participation.
• Fracturing labor market: Need for individual-focused pension arrangements.
• Dilemma: Balancing individual-based DC accumulation with post-retirement income security and flexibility.

9. Performance of India’s Pension Sector

Performance of India’s Pension Sector

• India’s pension index: Improved from 44.5 in 2022 to 45.9 in 2023.
• Pension system: Earnings-related, EPF, and supplementary employer-managed schemes.
• National Pension Scheme (NPS) and Atal Pension Yojana (APY) subscribers: Increased from 623.6 lakh to 735.6 lakh (FY23-FY24).
• APY subscribers: Increased from 501.2 lakh to 588.4 lakh (FY23-FY24).
• APY subscriber profile:5% female, 46.7% aged 18-25, 92% with ₹1,000 pension.
• Pension coverage: Increased from 1.2% to 5.3% of total population (FY17-FY24).
• AUM under NPS and APY: Increased from 1.1% to 4% of GDP (FY17-FY24).

Outlook for Pension Sector

• NPS growth potential: Corporate employees, self-employed, and rural population.
• Demographic advantage: Young population and increasing life expectancy.
• Financial literacy: Essential for pension benefits.
• Pension accounts for all: Empowering women and young adults.
• Government and industry role: Nudging people to join pension schemes.
• Early savings benefits: Power of compounding for substantial retirement income.

10. Mechanisms to ensure regulatory coordination and overall financial stability

Financial Stability and Regulation

• Financial stability: Crucial for economic growth and prosperity.
• Government’s role: Policies, regulations, and measures to safeguard financial sector.
• FSDC: Facilitates interaction among financial sector regulators.
• RBI’s role: Monitoring systemic risks, implementing monetary policy, publishing FSR.
• FSAP: Comprehensive assessment of financial industry.
• Basel III reforms: India largely compliant, implementation ongoing.
• Compensation standards: In place for significant banks, insurers, and asset managers.
• OTC derivatives: Significant progress in trade reporting, central clearing, and platform trading.
• NBFI resilience: India in total compliance with SFT requirements.
• Financial System Stress Indicator (FSSI): Monitors aggregate stress level.
• FSSI trends: Gradual easing of stress in H2 FY24, except NBFC and money market segments.
• Government debt market stress: Declined due to falling yields and higher foreign portfolio debt inflows.
• Foreign exchange market stress: Reduced due to declining volatility and rangebound exchange rate.
• Banking system stress: Remained subdued due to improving soundness.
• Real sector stress: Moderated due to sound macroeconomic fundamentals.
• NBFC sector stress: Increased due to declining capital ratios and rising borrowing costs.

Basic

1.Financial stability refers to the ability of the financial system to function smoothly and efficiently, absorbing shocks without causing widespread disruption. It involves maintaining a balance between risk and return, preventing systemic failures, and ensuring the flow of credit to support economic growth. A stable financial system promotes investor confidence, protects consumers, and contributes to overall economic prosperity. Key elements include sound regulation, effective supervision, and robust market infrastructure.

2. What are Basel Norms?

• International banking regulations set by Basel Committee on Banking Supervision (BCBS).
• Aim to strengthen global banking system.  
• Focus on risks to banks and financial system.  

Basel Committee on Banking Supervision (BCBS)

• Established by G10 countries in 1974.  
• Expanded membership to 45 members from 28 jurisdictions.  
• Promotes cooperation on banking supervision.  
• Enhances understanding of supervisory issues.  

Why Basel Norms?

• Banks face credit risk from borrowers.
• Need to maintain capital as security against defaults.  
• Basel Norms provide guidelines for capital adequacy.  

Basel Accords

• Basel I (1988): Focused on credit risk, minimum capital requirement of 8% of risk-weighted assets (RWA).  
• Basel II (2004): Three pillars: capital adequacy, supervisory review, market discipline.  
• Basel III (2010): Response to 2008 financial crisis, focuses on capital, leverage, funding, and liquidity.  

Key Provisions of Basel III

• Capital adequacy ratio: 12.9%
• Tier 1 capital ratio: 10.5%
• Tier 2 capital ratio: 2%
• Capital conservation buffer: 2.5%
• Counter-cyclical buffer: 0-2.5%
• Leverage ratio: 3%  
• Liquidity ratios: LCR and NSFR  

Implementation in India

• India adopted Basel I in 1999.  
• Basel II partially implemented.
• Basel III implementation deadline extended due to COVID-19

ASSESSMENT AND OUTLOOK

Overall Performance

• Domestic credit increased from 50.6% to 54.7% of GDP (2010-2021).
• Improved asset quality, profitability (CRAR, RoA, RoE) in banks.
• Stable stock market despite geopolitical uncertainties.

Financial Inclusion and Deepening

• Overcoming credit boom challenges and bust aftermath.
• Progress in financial inclusion but room for improvement.
• Lower financial intermediation costs crucial for development.

Vision for a Robust Financial Sector

• Highly competitive and accessible banking.
• Low intermediation costs, efficient credit and equity access.
• Well-regulated and efficient capital markets.
• Support for MSMEs, insurance, and retirement security.
• Gap in insurance and pension assets compared to global peers (India: 19% & 5%, USA: 52% & 122%, UK: 112% & 80%).

Future Trends and Challenges

• Focus on Artificial Intelligence/ Machine Learning (AI/ML), Decentralised Finance, Internet of Things (IoT), etc for digital payments.
• India aiming to be a fintech hub.
• Transition to data-based lending for small businesses.
• Regulatory review and alignment with global best practices.
• Customer-centricity as a key focus.
• Shift from banking dominance to capital market importance.
• Managing capital market risks and vulnerabilities.

 

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