Banking & Monetary Policy

Banks Enter India’s Pension Asset Space

Context: In a significant reform in India’s pension ecosystem, the Pension Fund Regulatory and Development Authority (PFRDA) has approved a framework permitting banks to sponsor pension fund entities for managing assets under the National Pension System (NPS). This marks a shift from the earlier, limited role of banks as service facilitators to active participants in pension asset management.

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What Has Changed?

Until now, Scheduled Commercial Banks functioned mainly as Points of Presence—responsible for onboarding NPS subscribers, collecting contributions, and providing customer services. Under the new framework, eligible banks can now establish and sponsor a Pension Fund Manager (PFM), enabling them to directly manage retirement savings invested through NPS.

Eligibility for this expanded role will be aligned with RBI prudential norms, including minimum net worth, market capitalisation, governance standards, and overall financial soundness.

This ensures that only stable and well-capitalised banks enter the pension fund management space.

About the National Pension System (NPS)

The National Pension System is a voluntary, defined-contribution retirement scheme regulated by PFRDA. It is open to all Indian citizens and Overseas Citizens of India aged 18–70.

Key features include:

  • Subscriber Choice: Individuals can select their Pension Fund Manager and asset allocation mix.
  • Portability: A Permanent Retirement Account Number (PRAN) remains valid across jobs and locations.
  • Investment Structure: Contributions are professionally invested across equities, government securities, corporate bonds, and select alternative assets, generating market-linked returns.

Withdrawal and Annuity Provisions

At the normal retirement age of 60:

  • Government subscribers may withdraw up to 60% of the accumulated corpus tax-free.
  • At least 40% must be invested in an annuity purchased from PFRDA-empanelled providers, providing a taxable monthly pension.
  • For non-government subscribers, recent reforms permit lump-sum withdrawal of up to 80%, offering greater flexibility.

Role of PFRDA

The Pension Fund Regulatory and Development Authority functions as the statutory pension regulator under the Ministry of Finance.

Established as an interim body in 2003 and granted statutory status through the PFRDA Act, 2013, it aims to promote old-age income security.

PFRDA regulates pension funds, sets investment and governance norms, benchmarks performance, and administers key schemes such as NPS, Atal Pension Yojana (APY), Unified Pension Scheme (UPS), and NPS Vatsalya.

Why This Matters

Allowing banks to manage pension assets can deepen competition, improve fund management expertise, and enhance long-term returns for subscribers.

At the same time, RBI-aligned eligibility norms help safeguard retirement savings by ensuring prudential oversight and financial stability.

Bank Frauds in India: Fewer Cases, Bigger Losses

Context (RBI): The Reserve Bank of India in its Report on Trend and Progress of Banking in India 2024–25 highlights a paradox: fraud cases declined sharply, but the total amount involved surged, pointing to concentration of risk in high-value advances.

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Key Findings from the RBI Report

  • Overall Trend:
    Fraud cases declined to 23,879 in FY25 from 36,052 in FY24, but the value jumped to ₹34,771 crore from ₹11,261 crore.
  • Court-Linked Reclassification:
    A major spike arose from 122 cases worth ₹18,336 crore, re-reported after compliance with the Supreme Court’s principles of natural justice requiring borrower hearings.
  • H1 FY26 Snapshot (Apr–Sep):
    Cases fell to 5,092 (from 18,386), while the amount involved rose to ₹21,515 crore.
  • Digital Frauds:
    Card and internet frauds constituted 66.8% of cases by number in FY25, reflecting high-frequency, low-value incidents.
  • Loan (Advances) Frauds:
    Advances-related frauds accounted for about 33.1% of the total amount by value, despite fewer cases.
  • Bank-Group Pattern:
    • Private banks: 59.3% of cases
    • Public Sector Banks (PSBs): 70.7% of the total amount involved

Why the Number of Frauds Fell

  • Digital Transaction Controls:
    AI-based monitoring, velocity checks, and risk-based authentication across core banking platforms have curtailed small-value fraud attempts.
  • Stronger KYC Regime:
    Mandatory re-KYC, video-based customer identification, and centralised KYC records reduced impersonation and mule accounts.
  • Early Warning Systems (EWS):
    Automated alerts for unusual account behaviour enabled faster freezing of suspicious transactions, aided by account-level dashboards.
  • Consumer Awareness:
    SMS alerts, helplines, and nationwide cyber awareness campaigns improved customer response time to fraud attempts.

Why Value of Frauds Rose Sharply

  • Legacy Loan Frauds:
    Large corporate and consortium loan frauds often surface after forensic audits, inflating total values in a single year.
  • Reclassification Impact:
    Earlier under-reported or disputed cases were re-examined and reported afresh, adding high-ticket amounts.
  • Concentration in Advances:
    Credit-related frauds involve large exposure sizes, unlike retail digital frauds that are frequent but low in value.

Way Forward

  • Risk-Based Supervision:
    Intensify scrutiny of large-value advances using dynamic risk-scoring and borrower heat maps.
  • Unified Fraud Intelligence:
    Integrate fraud registries across banks and non-banks for real-time red-flag sharing through interoperable platforms.
  • Digital Payment Safeguards:
    Introduce cooling-off periods and beneficiary verification for first-time or high-risk transactions.
  • Board-Level Accountability:
    Mandate periodic fraud-risk reviews by bank boards with fixed response timelines and governance dashboards.

RBI Measures for Macroeconomic Stability

Context: To reinforce macroeconomic stability amid easing inflation and resilient growth, the Reserve Bank of India (RBI)—through the Monetary Policy Committee (MPC) and liquidity management tools—has announced a coordinated set of monetary and liquidity measures.

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Key Measures by the Monetary Policy Committee (MPC)

1. Repo Rate Cut (25 basis points to 5.25%)

The RBI reduced the repo rate—the rate at which it lends short-term funds to banks against government securities.

Objective: Stimulate economic activity by lowering borrowing costs and ensuring adequate liquidity.

Impact: Bank lending rates and EMIs decline, corporate borrowing becomes cheaper, and money-market rates align more closely with the policy rate.

2. “Goldilocks” Forecast Revisions

The RBI revised FY26 GDP growth upward to 7.3% and lowered the CPI inflation projection to 2.0%.

A “Goldilocks” scenario denotes strong growth with low inflation—neither overheating nor recessionary.

Impact: Improved market sentiment, softer bond yields, higher equity valuations, and better anchoring of expectations.

About the Monetary Policy Committee (MPC)

  • Nature: Six-member statutory body (established in 2016 via amendment to the RBI Act, 1934).
  • Mandate: Maintain price stability while supporting growth.
  • Inflation Target: CPI at 4% ± 2% under the inflation-targeting framework.
  • Composition: RBI Governor (Chair), one Deputy Governor, one RBI official, and three Government-appointed external members (four-year terms).
  • Process: Decisions by majority vote; Governor has a casting vote; minimum four meetings annually.
  • Legal Basis: Section 45ZB; decisions binding on the RBI.

Supplementary Liquidity Measures by the RBI

1. Open Market Operations (OMO)

  • Action: Purchase of government securities worth ₹1 lakh crore.
  • Objective: Inject durable liquidity and stabilise bond yields across maturities.
  • Impact: Higher system liquidity, stable call-money rates, and rising bond prices.

2. USD/INR Forex Buy–Sell Swap ($5 billion, 3-year maturity)

  • Mechanism: RBI buys dollars now (injecting rupees) and sells them back later.
  • Objective: Boost rupee liquidity while moderating forex volatility.
  • Significance: Adjusts liquidity without permanently expanding the RBI’s balance sheet (unlike OMO).
  • Impact: Improved banking liquidity, predictable hedging costs, and balanced dollar supply.

Overall Significance

Together, the rate cut, optimistic macro forecasts, OMOs, and forex swaps signal a calibrated easing—supporting growth, anchoring inflation expectations, and preserving financial stability. This multi-instrument approach strengthens confidence in India’s macroeconomic resilience.

Nine Years After Demonetisation: Lessons and Realities

Context: Nine years after the 2016 demonetisation drive, police in Ghaziabad uncovered a fraud racket offering to exchange old ₹500 and ₹1,000 notes — indicating that a small underground market for demonetised currency persists.
The episode revives debate on whether the policy achieved its intended economic outcomes.

Background

On 8 November 2016, the Government of India announced demonetisation of ₹500 and ₹1,000 currency notes, which constituted 86% of total currency in circulation, citing objectives such as:

  • Curbing black money and counterfeit currency
  • Promoting digital payments
  • Strengthening formalisation of the economy

Key Data and Trends

  • Currency with the Public: Fell sharply from ₹17.97 lakh crore (Nov 2016) to ₹7.8 lakh crore (Jan 2017).
  • Current Level: ₹37.29 lakh crore (as of Oct 2025, RBI data) — more than double pre-demonetisation levels.
  • Currency-to-GDP Ratio:
    • Pre-demonetisation (2016–17): 8.7%
    • Pandemic peak (2020–21): 14.5%
    • 2025: 11.1%, still higher than the U.S. (7.9%) or China (9.5%).
  • Digital Payments: UPI transactions grew at 49% CAGR (FY23–FY25), with monthly volumes exceeding ₹20 lakh crore.

Analysis

  • Mixed Success: While demonetisation catalysed digital payment adoption, cash usage remains deeply rooted, especially in the informal sector.
  • Temporary Disruption: Short-term liquidity shocks impacted MSMEs, agriculture, and the unorganised sector.
  • Informal Economy: About 80–85% of India’s employment is still informal and cash-dependent.
  • Tax Base Expansion: Direct tax returns grew from 4.9 crore (2016–17) to 8.9 crore (2024–25), suggesting some formalisation effect.
  • Counterfeit Currency: RBI data shows fake note detection decreased by 31% between 2016 and 2024.

Structural Implications

  • Digital Ecosystem: Strengthened through UPI, Aadhaar, and Jan Dhan accounts.
  • Behavioural Change: Increased trust in digital finance, though cash continues as a safety asset.
  • Monetary Stability: Currency-to-GDP ratio declining implies faster GDP growth vis-à-vis cash expansion.
  • Future Challenge: Balancing inclusion with cash-independent growth.

Conclusion

Demonetisation’s legacy is complex — it accelerated India’s digital transformation but failed to permanently reduce cash dependency.
The policy’s long-term impact lies less in cash withdrawal and more in shaping a hybrid economy combining cash resilience with digital innovation.

RBI Cautions States on Fiscal Discipline

Context: The Reserve Bank of India (RBI) has warned states against fiscal slippages, rising borrowing, and pre-election populist spending, highlighting risks to long-term financial stability. Pre-election populist spending refers to the increase in subsidies and welfare outlays mainly to attract voter support, rather than to promote sustained economic growth.

Key Concerns Highlighted by RBI

  1. Rising Borrowing Costs:
    Yields on State Development Loans (SDLs) have risen sharply. Higher yields mean states must pay more interest, increasing the overall debt burden.
  2. Increasing Market Borrowing:
    States have borrowed ₹5.23 trillion till October 2025, which is 62% of their FY26 borrowing plan, compared to ₹4.37 trillion in the same period last year. This indicates faster-than-expected fiscal stress.
  3. Fiscal Deficit Pressure:
    The combined fiscal deficit for states is expected to be 3.2% of GDP. However, analysts caution that pre-election expenditure could push this above the recommended limits, threatening fiscal stability.
  4. Pre-Election Populist Spending:
    During eight state elections (2023–25), states spent nearly ₹68,000 crore on short-term welfare schemes.
  • For example, Bihar allocated 32.48% of its tax revenues to such schemes, reducing funds available for infrastructure and long-term development.

What are SDLs?

State Development Loans (SDLs) are bonds issued by state governments to raise funds for development expenses and fiscal deficit management. These are auctioned by the RBI and carry interest, contributing to long-term debt liabilities of states.

RBI Recommendations

RecommendationPurpose
Productive SpendingShift funds from temporary subsidies toward capital expenditure (roads, power, irrigation) that builds future growth.
Fiscal PrudenceAdhere to FRBM Act targets to maintain balanced budgets and macroeconomic stability.
Borrowing StrategySpread borrowings across maturities and maintain transparent communication to lower interest costs.
Fiscal TransparencyClearly report contingent liabilities and off-budget borrowings to avoid hidden debt risks.

Why This Matters

  • States account for nearly 60% of public sector capital expenditure in India.
  • Excessive populist spending reduces funds for development, slowing growth and worsening debt sustainability.
  • Maintaining fiscal discipline strengthens investor confidence, supports stable interest rates, and ensures inter-generational equity.

Conclusion

RBI’s caution underscores the importance of sustainable fiscal management. While welfare spending remains essential, states must prioritize long-term developmental spending and maintain transparent and prudent financial practices to safeguard economic stability.

RBI’s Inflation Targeting Framework and the Debate on Continuity

Context: The existing flexible inflation targeting framework of Reserve Bank of India (RBI) is set to expire in March 2026. RBI had sought views from economists, market participants and other stakeholders on whether the current target, band, and measure should continue. Most respondents back the continuation of the existing structure. 

Relevance of the Topic: Prelims: Key Features of the 2015 Monetary Policy Framework. 

The monetary policy framework in India has evolved over the years. From relying on multiple indicators such as money supply and wholesale prices, the RBI shifted its focus to retail inflation in 2014. 

In February 2015, a new Monetary Policy Framework Agreement was signed between the Government of India and the RBI, which institutionalised inflation targeting in India.

Key Features of the 2015 Monetary Policy Framework

  • The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth.
  • The framework is operated by the RBI, which uses instruments such as the repo rate to achieve the target.
  • The inflation target is fixed at 4% CPI inflation, with a tolerance band of +/-2 % (2-6%).
  • The inflation target is decided by the Government of India in consultation with the RBI, and is to be set once every five years. The current target has been notified till March 31, 2026.
  • The relevant measure of inflation is the Consumer Price Index (CPI-Combined) published by the National Statistical Office (NSO), Ministry of Statistics and Programme Implementation. 
  • The RBI is deemed to have failed in its mandate if inflation remains above 6% or below 2% for three consecutive quarters.
  • In case of such failure, the RBI must submit a written report to the Government explaining the reasons for the failure, remedial measures, and the time frame within which inflation will be brought back to the target.

Role of the Monetary Policy Committee (MPC)

  • The MPC was constituted in 2016 as a statutory body to set the policy repo rate required to achieve the inflation target.
  • It comprises six members: RBI Governor (Chairperson), the Deputy Governor in charge of monetary policy, one RBI officer nominated by the RBI Board, and three external members appointed by the Government.
  • Decisions are taken by majority vote, with the Governor having a casting vote in case of a tie.
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Performance of the Flexible Inflation Targeting (FIT) Regime (2016-2025)

  • Inflation has declined significantly since the adoption of FIT: from nearly 10% in 2012-13, CPI inflation is projected to average 3.1% in 2025-26, the lowest in the FIT era.
  • The framework has anchored inflation expectations of households and markets, thereby improving monetary policy credibility.
  • It has enhanced macroeconomic stability by reducing uncertainty for consumers and investors.
  • Low and stable inflation has supported sustainable growth, as extreme price fluctuations erode consumer purchasing power and discourage investment.
  • India’s adoption of FIT has brought it in line with global best practices, where most modern central banks follow inflation targeting frameworks.

Review of Flexible Inflation Targeting (FIT) Regime: 

The FIT regime requires a review every five years. The current review must be completed by March 2026. The RBI’s recent discussion paper has sought comments on key issues:

  • Whether monetary policy should target headline inflation or core inflation.
  • Whether the 4% inflation target remains optimal.
  • Whether the tolerance band (2-6%) should be revised.
  • Whether the target should be a point (4%) or a range only.

Former members of the Monetary Policy Committee (MPC) are largely in favour of retaining the targets as per the existing Flexible Inflation Target (FIT) regime and want to continue to focus on keeping headline Consumer Price Index (CPI) inflation at 4% in the medium term.

Also Read: Time to Review Inflation Targeting 

ICICI Bank’s Minimum Average Balance Hike 

Context: ICICI Bank has sharply increased the Minimum Monthly Average Balance (MAB) for new savings accounts. This has triggered debate over financial inclusion as Public Sector Banks (PSBs) move towards zero-MAB policies. 

Relevance of the Topic: Prelims: About RBI's stand on Minimum Monthly Average Balance (MAB) Policy. 

ICICI Bank’s Minimum Average Balance Hike

  • ICICI Bank, India’s second-largest private lender, has sharply increased the Minimum Monthly Average Balance (MAB) requirement for new savings account customers effective 1 August 2025.
  • New MAB levels:
    • Metro & Urban: ₹50,000 (earlier ₹10,000) → 5× hike
    • Semi-Urban: ₹25,000 (earlier ₹5,000)
    • Rural: ₹10,000 (earlier ₹2,500) 
  • Exemptions:
    • Basic Savings Bank Deposit Accounts 
    • Pensioners’ accounts
    • Salary accounts
    • Customers who maintain savings plus fixed deposit amount of up to ₹2 lakh with the bank. 

If a customer fails to maintain the required MAB, the bank will levy a penalty equal to 6% of the shortfall amount or ₹500, whichever is lower. 

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RBI’s Position on Minimum Average Balance Policy:

  • The Governor of Reserve Bank of India (RBI) has clarified that Minimum Average Balance (MAB) requirements do not fall under RBI regulation. Banks are free to set their own MAB thresholds, with no regulatory cap on the amount.

Why did ICICI Bank do this?

  • Few customers have less than ₹50,000 MAB: Low-balance customers are not the bank’s core segment. High MAB customers are more likely to keep money parked long-term, providing a cheap source of funds.
  • Low-balance accounts = high cost and low returns: These accounts still use customer service, tech infrastructure, and compliance resources but generate less revenue.
  • Fraud risk: Lower-balance accounts see more mule account misuse (used for illegal fund transfers).
  • Free up resources: Better service for premium customers, tech upgrades, and more fee-based product launches.

Impact on ICICI Bank: 

  • Limited business impact: Very few current customers fall below the new threshold.
  • Applies only to new accounts; existing customers are unaffected.

Why the Backlash?

  • Seen as anti-financial inclusion: Many urban customers do not even earn ₹50,000/month. Demanding they keep almost an entire month’s income idle in a low-interest savings account feels exclusionary.
  • Contrast with PSBs: The hike comes while public sector banks (PSBs) are removing MAB requirements to promote financial inclusion. E.g., Multiple PSBs (PNB, BoB, Indian Bank, etc.) recently waived MAB penalties entirely.

Flipkart secures NBFC licence from RBI

Context: Walmart’s Flipkart has secured an Non-Banking Financial Company (NBFC) licence from the Reserve Bank of India allowing it to directly disburse loans for EMIs and BNPL (Buy Now, Pay Later) schemes. This is the first time the RBI has granted a large e-commerce player in India a NBFC licence. 

Relevance of the Topic:Prelims: Key facts about Non-Banking Financial Company (NBFC); NBFCs vs Banks. 

NBFC licence to Flipkart

  • The NBFC licence will allow Flipkart to lend directly to customers on its platform and through its fintech App- ‘super.money’. 
  • Flipkart can offer loans independently rather than through partners, potentially boosting profitability. 
  • It may also offer financing to sellers on the platform.

What is a Non-Banking Financial Company?

  • NBFC is the Non-banking financial institution registered under the Companies Act, 1956, that provides diverse financial facilities like lending, pension and insurance. 
  • NBFCs do not have a full banking license and cannot accept deposits from the public. They cannot issue cheque books or open savings accounts. 
  • NBFCs have played a pivotal role in making formal credit accessible to MSMEs, retail sectors and underserved populations.
    • The sector contributes 12.5% to the country's GDP. 
    • The sector's credit share has grown from 15% in 2014 to 22.5% of total Scheduled Commercial Bank credit in 2024. 
    • The growth of NBFCs has been supported by diverse funding streams like bank loans, commercial papers and other debt instruments- where term loans and debentures consist of 75% of borrowings. 
  • Regulation: The working and operations of NBFCs are regulated by RBI within the framework of the Reserve Bank of India Act, 1934.

Types of NBFCs:

  • Based on Asset-Liability Structures: Deposit-taking NBFCs (NBFCs-D) and non-deposit-taking NBFCs (NBFCs-ND).
  • Based on Systemic Importance: Among non-deposit taking NBFCs, those with asset size of Rs 500 crore or more are classified as non-deposit taking systemically important NBFCs (NBFCs-ND-SI).

NBFCs vs. Banks:

The NBFC sector plays an important role in supplementing credit creation along with the Banks.

Difference between Banks and NBFCs
CharacteristicsBanksNBFCs
DepositsAccepts all types of depositsCannot accept demand deposits (some NBFCs can accept fixed deposits after RBI’s approval)
Deposit insurance of DICGCApplicable (up to Rs.5 lakh per depositor)Non-Applicable
Payment and Settlement system of the RBISupports RTGS, NEFT, IMPS etc.,Not supported. Cannot issue their own cheque books.
Foreign investmentUp to 74%Up to 100%
Cash Reserve RequirementApplicableNot Applicable
Capital Adequacy NormsApplicableApplicable only to Deposit-taking NBFCs and Systematically Important NBFCs (CRAR - 15%)
SLRApplicableApplicable only to Deposit-taking NBFCs (SLR - 15%)
Incorporated underBanking Regulation Act, 1949Incorporated under Companies Act 2013; and regulated under RBI and various bodies depending on category.

Role of NBFCs in Economy:

  • Credit access to the underserved sectors like small businesses, rural areas, and the informal sector & MSMEs. 
  • Promoting financial inclusion by institutionalisation of the lending market in India, eliminating the unregulated lenders. 
  • Driving infrastructural growth by funding the long-term and risky infrastructure projects, as banks lack the capacity to fund large projects due to their asset-liability mismatch. 
  • Strengthening the financial market through the activities like leasing, hire-purchase and securitisation, improving the overall efficiency of the financial system. 
  • Contributing capital formation as the NBFCs mobilises the resources, savings and investments to foster economic growth.

RBI cuts Repo Rate by 25 bps

Context: RBI’s Monetary Policy Committee has decided to cut the repo rate by 25 basis points to 6%. The decision comes amidst heightened global economic uncertainty in the face of reciprocal tariffs announced by the US.  

MPC has slashed the GDP growth to 6.5% in FY26 from 6.7% projected earlier. Retail inflation is expected to be 4% in FY26. 

Relevance of the Topic:Prelims: Repo Rate; Reverse Reo Rate. 

Repo Rate and Reverse Repo Rate

  • Repo Rate: The interest rate that the RBI charges when commercial banks borrow money from it. 
  • Reverse Repo Rate: The interest rate the RBI pays commercial banks when they park their excess cash.

Reduction of Repo Rate: Promotes Economic Activity

  • When the RBI wants to encourage economic activity in the economy, it reduces the repo rates. 
  • This enables commercial banks to bring down the interest rates they charge (on their loans) as well as the interest rate they pay on deposits. Interest rates on home, personal, vehicle loans and deposit loans come down. 
  • This incentivises people to spend money as keeping their savings in the bank pays back a little less interest.
  • Businesses are incentivised to take new loans for new investments as new loans now become cheaper. 

Increase in Repo Rate: Control Inflation:

  • When the RBI wants to control inflation, it increases the repo rate. 
  • Banks charge more interest to their borrowers, as they have to pay more interest to borrow from the RBI. 
  • At a macro level, this inhibits people from borrowing money as well as from spending, which in turn reduces the amount of money in the market, and thus negates inflation.

Repo and Reverse repo rates are often referred to as the “benchmark” interest rates in the economy. Using these rates, the RBI sets the tone for all other interest rates in the banking system, and in the broader economy.

RBI to buy ₹80,000 Crore Government Securities

Context: The Reserve Bank of India (RBI) has announced an open market operation (OMO) purchase to purchase government securities worth ₹80,000 crore in April 2025. This comes after major expectations of further liquidity operations by the Reserve Bank of India.

Relevance of the Topic: Prelims: Key facts about OMOs; G-Secs; Liquidity Management measures by RBI.

Major Highlights

  • RBI will conduct fresh purchase of government securities under OMOs for an aggregate amount of ₹80,000 crore. This will be carried out in four tranches of ₹20,000 crore each. 
  • The move is in continuation of the RBI's recent measures to inject liquidity into the financial system.
    • Earlier in March 2025, RBI conducted OMO purchases of government securities worth Rs 1 lakh crore in two tranches of Rs 50,000 crore each. 
    • RBI also held a dollar-rupee buy/sell swap auction of $10 billion for 36 months.

Open Market Operations (OMO)

  • OMOs are a key monetary policy tool used by the RBI to regulate liquidity in the banking system by buying or selling government securities (G-Secs) in the open market.
  • When RBI purchases government securities, it injects liquidity into the system. This encourages banks to lend more which can boost economic activity. 
  • When RBI sells government securities, it absorbs excess liquidity and helps to control inflation by reducing the money supply.
  • OMOs are crucial for maintaining stable interest rates, ensuring adequate credit availability, and managing overall financial stability in the economy.

Government Securities (G-Secs)

  • G-Sec is a tradable debt instrument issued by Central government or State governments. It acknowledges the government's debt obligation.
  • Types of G-secs:
    • Short-Term Government Securities (maturity <1 year): Treasury Bills, Cash Management Bills.
    • Long-Term Government Securities (Maturity >1 year): Dated G-Secs.
  • G-Secs are issued through auctions conducted by Reserve Bank of India, through the electronic platform E-Kuber. 

Also Read: RBI’s Liquidity Moves and Forex Market Intervention 

The RBI’s liquidity support is crucial as it comes at a time when economic recovery in India is showing mixed signals, with inflationary pressures, slowing industrial output, and the global economic slowdown affecting business sentiments.

RBI’s Liquidity Moves and Forex Market Intervention

Context: The Reserve Bank of India has conducted several dollar-rupee buy/sell swap auctions and open market operations since January 2025 to manage volatility in the forex market, and infuse liquidity into the banking system. These measures supplement the interest rate cut announced by the RBI Governor in February 2025 to boost economic activity. 

Relevance of the topic:

Prelims: Exchange Rate system, Open market operations, Forex swap.

Mains: Indian Economy and Issues of Liquidity & Monetary Policy. 

Reasons behind RBI Intervention

  • The Indian rupee follows a managed floating exchange rate regime. This means that the central bank (RBI) intervenes in the foreign exchange market to buy or sell dollars in order to stabilise the value of the rupee. 
  • Due to several economic and geopolitical reasons, most emerging markets (including India), are experiencing a massive outflow of foreign portfolio capital.
    • E.g., Foreign investors have withdrawn approximately $29 billion from Indian equities in the period between October 2024 to March 2025, marking the largest outflow in any six-month period.
  • This has put pressure on the exchange rate, and the rupee sharply depreciated from 83.5/dollar on September 22, 2024, to cross 87.5/dollar on February 7, 2025. 
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Steps Taken by RBI:  

1. Interest Rate Cut:

  • In February 2025, RBI reduced the Repo rate by 25 basis points to 6.25% (first cut in nearly 5 years). 
  • An interest rate cut reduces the cost of borrowing and encourages domestic firms and households to spend more. 
  • However, if liquidity in the banking system is inadequate, a rate cut may not be effective as banks’ ability to lend money will be limited. In such a scenario RBI can conduct open market operations. 

2. Open Market Operations (OMOs):

  • In March 2025, RBI announced to conduct OMO purchases of government securities worth ₹1 lakh crore in two tranches of Rs 50,000 crore each.
  • The central bank’s buying (or selling) of government bonds to influence liquidity in the banking system is called an open market operation (OMO).
    • Bond Purchase → Increases liquidity (more money in the banking system). 
    • Bond Sale → Reduces liquidity (less money in circulation). 
  • Presently, RBI is buying government securities from the banks in exchange for domestic currency, thereby increasing liquidity in the banking system. 
  • Impact of OMOs:
    • Short-term bond yields have fallen, making borrowing cheaper. 
    • However, long-term bond yields remain high, meaning long-term investments are still costly. 
    • The RBI may need to target long-term bond yields through further measures. 
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3. Dollar-Rupee Buy/Sell Swap Auction:

  • RBI has announced to conduct a USD/INR Buy/Sell Swap auction for ₹10 billion with a tenor of 36 months in March 2025. Earlier, RBI conducted a $5.1-billion swap in January 2025 for a six-month tenure. 
  • A buy / sell forex swap by a central bank is an instrument where the central bank buys foreign currency from a commercial bank in exchange for domestic currencies, with a commitment to reverse the transaction at a predetermined future rate and date.
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  • Objectives of Forex Swaps:
    • Liquidity Infusion – When RBI buys dollars, it injects rupees into the banking system, helping banks lend more. 
    • Exchange Rate Stability – The dollar-rupee buy/sell swaps add dollars to the RBI’s forex reserve and improve the ability of the central bank to intervene in the forex market. 

OMO and the forex swap have tried to create a pro-growth policy environment by infusing durable liquidity in the banking system and reducing volatility in the forex market. These measures are aimed at reversing the recent slowdown in India’s real GDP growth. 

Way Forward

  • Continued Forex Market Intervention: The RBI should continue to use forex swaps tactically while keeping a watch on their effect on forward premia and exchange rate stability. E.g., Recent geopolitical events have resulted in a temporary softening of the US dollar against major currencies, bringing some relief to emerging markets such as India.
  • Focus on Long-Term Bond Yields: To make the environment more favourable for long-term investments, the RBI may consider calibrated steps like buying longer-term government papers via OMOs. E.g., Analogous interventions had worked well in earlier phases of economic slowdown (post-COVID recovery).
  • Monitoring Inflation Pressures: The RBI needs to tread carefully to contain inflation pressures while safeguarding growth, particularly when the government has re-oriented policy priorities by stimulating domestic consumption through tax cuts. 

IMF raises concerns on NBFCs’ over-exposure

Context: A recent report by the International Monetary Fund (IMF) titled “India Financial System Stability Assessment” highlighted that stress in the Non-Banking Finance Companies (NBFCs) may pose risk in the financial system due to their overexposure to the power and infrastructure sector.

Relevance of the Topic: Prelims: NBFCs Mains: NBFCs- Risks and Way forward

Findings of the IMF Report

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  • NBFCs Over-Exposure:
    • NBFCs (particularly infrastructure financing companies) have an excessive concentration of loans in the power sector, which has been historically plagued by structural inefficiencies.
    • In FY24, 63% of power sector loans were from the three largest Infrastructure Financing Companies. This increased from 55% in 2019-20. 
  • Dependence on Market Instruments and Bank Borrowings:
    • In Q2 FY24, 56% of power sectors’ lending was financed by market instruments and only the rest by bank borrowings.
    • Since FY19, the dependence on bank borrowings for financing their lending has increased, raising systemic risk. 
    • State-owned NBFCs like IREDA are at a higher risk.
  • Limited Regulatory Support compared to Banks:
    • Unlike banks, NBFCs cannot accept demand deposits and their funds are not insured.
    • They lack direct access to RBI’s liquidity facilities, making them more vulnerable to financial shocks.
  • Cascading Effect:
    • NBFC distress could have cascading effects across the financial system due to their deep inter-linkages with banks, mutual funds, and corporate bond markets.
  • Spillover Effect on Banks and Financial Markets:
    • Any financial distress in NBFCs could amplify stress across the banking system, leading to liquidity crises in mutual funds and bond markets.
    • Past crises, such as IL&FS and DHFL collapses, demonstrated how NBFC failures impact the broader economy.
  • Regulatory gaps for State-owned NBFCs:
    • State-owned NBFCs dominate the sector, with three government-backed Infrastructure Financing Companies (IFCs) holding one-third of total NBFC assets.
    • Unlike private NBFCs, state-owned entities are not subjected to large exposure limits, raising regulatory concerns.
  • Regarding status of Public Sector Banks:
    • In the event of a stagflation, public sector banks (PSBs) may have difficulties maintaining a capital adequacy ratio (CAR) of 9%.
      • CAR is the ratio of capital to risk-weighted assets, used to measure the bank’s ability to absorb losses. 
      • RBI mandates a 12% CAR for PSBs and 9% CAR for Scheduled commercial banks.
    • Though the likelihood of stagflation had receded in 2024, geopolitical risks and monetary policy miscalibration of major central banks could result in an increase in interest rates, which could slow economic growth.
    • PSBs are relatively more vulnerable because they have lower initial CARs and are more sensitive to credit risk.

Read More: Non-Banking Financial Company (NBFC) Sector 

IMF Recommendations

  • PSBs should strengthen their capital base, including by retaining their earnings instead of paying dividends to the government. This can ensure they support economic recovery in a potential future downturn. 
  • Regulatory parity: State-owned NBFCs should have the same regulatory burden as private sector NBFCs to create a level playing field.
  • Reducing over-reliance on Market instruments: NBFCs should diversify funding sources to reduce dependence on market instruments and bank borrowings.
  • Strengthening liquidity regulations: NBFCs, particularly those with significant infrastructure exposure, should comply with stricter liquidity norms to avoid asset-liability mismatches.
  • Enhanced Data sharing and Risk monitoring: Regular monitoring of NBFCs’ lending patterns and improved risk management frameworks are needed to prevent financial disruptions.
  • Prioritising financial stability over developmental motives: The government should balance financial stability with the developmental role of banks and NBFCs.

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