Banking & Monetary Policy

Central Bank Digital Currency (CBDC)

Context: As per the Reserve Bank of India (RBI), the value of the Central Bank Digital Currency (CBDC) or E-rupee in circulation has increased 334% to ₹1016 crore in FY25, from ₹234 crore in FY24. CBDC is a tokenised digital version of the Indian rupee launched by RBI in 2022.

Relevance of the Topic: Prelims: Key facts about Central Bank Digital Currency.

Use cases of CBDC:

Ongoing use cases of CBDC:

Funds settlement of secondary market transactions in Government Securities
Settlement of inter-bank lending and borrowing in the call money market.
Direct benefit transfers to farmers against generation of carbon credits and loans to tenant farmers under Kisan Credit Card.

What is a Central Bank Digital Currency (CBDC)?

Digital currency backed by the central bank of a country. Just like currency notes issued by the Central Bank, the CDBC is a legal tender and accepted for the payment of various transactions within a country.
It is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet. That is, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value.
It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.
CBDC, being a sovereign currency, holds unique advantages of central bank money viz. trust, safety, liquidity, settlement finality and integrity.

Features of CBDC

CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy
It appears as a liability on the central bank’s balance sheet
Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
Freely convertible against commercial bank money and cash
Fungible legal tender for which holders need not have a bank account
Expected to lower the cost of issuance of money and transactions

	Fiat Currency	CBDC	Crypto currency	Stable Coin
Issuer	Central Bank	Central Bank	Private Entity	Private Entity
Value	Derives its value from the guarantee provided by Central Bank	Derives its value from the guarantee provided by Central Bank	None	Value pegged to other currency such as Diem, TruelNR (Refer to Budget Video for more details)
Legal Tender	Yes	Yes	May be given status of Legal Tender Example: El Salvador	May be given status of Legal Tender
Medium of Payment	Yes	Yes	May be allowed	May be allowed.
Examples	Physical Currency Notes	eDINAR, Sistema, Petro, e-krona etc.	Bitcoin, Ethereum, dogecoin etc.	Diem, TruelNR, Tether etc.

Types of CBDC

Retail CBDC: CBDC that can be used for people for day-to-day transactions.
Wholesale CBDC: CBDC that can be used only by financial institutions such as Banks, NBFCs etc.

Legal Framework For Issuance of CBDC

Finance Act 2022 has amended the RBI Act, enabling it to introduce Central Bank Digital Currency. The definition of bank note was amended wherein RBI was allowed to issue both physical and digital currency by amending Section 2 of RBI Act, 1934.

Possible Designs of CBDC

Direct Model: In case of Direct model, the Central Bank issues CBDC and enables customers to directly open accounts with itself. So, in this case, the Central Bank engages with the public for opening accounts, facilitating payments through CBDC etc.
Indirect/Two-tiered model: In this case, the Central Bank issues CBDC and customers would maintain with the Central Bank. But it would not directly engage with the customers. It would outsource activities such as opening accounts, facilitating payments etc. to other Banks.

Benefits of CBDC

Subhash Chandra Garg Committee (2019) has recommended a ban on private cryptocurrencies on account of concerns such as volatility, instability, security risk and risk of funding illegal activities. However, the committee has highlighted that an official digital currency can have number of advantages such as:

Promote cashless economy by reducing Cash-to-GDP ratio.
Increase in Financial Inclusion
Stability and Resilience of payment system since CBDC would promote competition in the payment system and ensures that no single company dominates the payment ecosystem
Counter the Stable coins such as Diem which could be used for making payments.
Increase in effectiveness of Monetary Policy
Push to development of Fintech sector
Provide a real time picture of economic activity and hence better GDP estimates and efficient monetary policy formulation.
Traceability of transactions would crack down on corruption and money laundering.
As it being a sovereign currency, ensures settlement finality and thus reduces settlement risk in the financial system.
CBDCs could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems.
The e₹ system will bolster India’s digital economy, cashless economy, enhance financial inclusion, and make the monetary and payment systems more efficient.
Could ease current frictions in cross-border payments.
Counter the monopoly of private sector issued cryptocurrencies.

Challenges and Concerns

Potential Disintermediation of Banks as people may shift from depositing money in the bank to CBDC. This will lower the deposits with the banks which will force them to increase their deposit rates to attract customers. It may lead to an increase in the rate of interest on loans in the economy.
Accelerate Bank runs: By providing depositors a safe and liquid alternative to bank deposits, CBDCs may accelerate bank runs during a period of financial stress.
Security risks and financial system abuses: CBDC may be susceptible to cyber-attacks and other security breaches. Such attacks or breaches may be committed to misuse the CBDC for illicit activities.
Competition to private payment service providers: Introduction of CBDC could lead to direct competition with private payment providers (such as Paytm, Google pay etc). This may reduce their incentives to invest in innovation.
Higher Burden on the RBI: If the RBI adopts "Direct Model", it will have to directly engage with the public for opening accounts and hence overall burden on the RBI could increase. This may in turn lead to neglect of its core activities.
Reputation risk: Security breaches on the CBDC may dent public confidence in the RBI.
Data privacy issues: Traceability feature of CBDC would have impact on Right to Privacy of the Individuals. Hence, the need for strong data regulation law in India.

CBDC more environment friendly than other cashless modes: RBI report

Context: Central bank digital currency (CBDC) or e-rupee, if designed keeping in mind the environment, social and governance (ESG) objectives, can be more environment friendly compared to alternative cashless methods, according to the RBI report.

CBDC and environment

CBDCs are significantly more energy efficient than current credit card processing centres, in part because the latter involve energy-inefficient legacy systems.
CBDC helps curb emissions by nullifying operations such as printing, storage, transportation, and replacement of physical currency.
Results of a climate stress-test revealed that public sector banks (PSBs) may be more vulnerable than private sector banks (PVBs) in India.

Climate-stress tests are scenario based exercises that assess the loss to the financial systems/entities due to climate related risks by adopting the methodology of traditional stress tests to climate related exigencies.

All about Central Bank Digital Currency

Central Bank Digital Currency (CBDC) is a digital form of currency notes issued by a central bank. The e₹ will provide an additional option to the currently available forms of money.
It is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet. That is, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value.
It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.
CBDC, being a sovereign currency, holds unique advantages of central bank money viz. trust, safety, liquidity, settlement finality and integrity.

The features of CBDC include

CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy
It appears as a liability on the central bank’s balance sheet
Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
Freely convertible against commercial bank money and cash
Fungible legal tender for which holders need not have a bank account
Expected to lower the cost of issuance of money and transactions

Type of CBDC to be issued

CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions. While Wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail transactions.
It is believed that Retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the Central Bank. Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure. Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

Model for issuance and management of CBDC

There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.
In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.
The Indirect model is akin to the current physical currency management system wherein banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification etc.

Forms of CBDC

CBDC can be structured as ‘token-based’ or ‘account-based’.
A token-based CBDC is a bearer-instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.
In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.
Also, in a token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine, whereas in an account-based CBDC, an intermediary verifies the identity of an account holder.
Considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash, while account-based CBDC may be considered for CBDC-W.

Advantages of CBDC over other digital payments systems

As it being a sovereign currency, ensures settlement finality and thus reduces settlement risk in the financial system.
CBDCs could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems.
The payment systems are available 24X7, 365 days a year to both retail and wholesale customers.
They are largely real-time, the cost of transaction is perhaps the lowest in the world, users have a wide array of options for doing transactions and digital payments have grown at an impressive CAGR of 55% over the last five years.
The e₹ system will bolster India’s digital economy, cashless economy, enhance financial inclusion, and make the monetary and payment systems more efficient.
CBDCs could ease current frictions in cross-border payments.
Traceability of transactions would crack down on corruption and money laundering.
Counter the monopoly of private sector issued cryptocurrencies.

De-dollarisation: the race to attain the status of global reserve currency

Context: While countries have tried to dethrone the dollar as the global reserve currency for many decades now for various reasons, of late such attempts have picked up pace in the aftermath of Russia’s invasion of Ukraine last year.

Status of Global Currencies

According to the BIS Triennial Central Bank Survey 2022, in terms of foreign exchange market turnover (daily averages), the dollar was the most dominant currency accounting for 88 per cent of the global forex turnover in 2022, followed by the Euro (31 percent), Japanese Yen (17), and Pound Sterling (13); the rupee accounted for a mere 2 percent of global currency market turnover.
Similarly, as per IMF’s COFER data, the dollar’s share of global foreign exchange reserves during 2022 Q4 stood at 58.4 percent, followed by Euro (20.5), Japanese Yen (5.5), Pound Sterling (5), Chinese Renminbi (2.7), Canadian dollar (2.4), Australian dollar (2), and Swiss Franc (0.2); India’s share was negligible.

What is De-dollarisation?

De-dollarisation refers to the replacement of the U.S. dollar by other currencies as the global reserve currency.
Attempts to de-dollarize have picked up pace in the aftermath of Russia’s invasion of Ukraine last year. The U.S. imposed several sanctions that restricted the use of the U.S. dollar to purchase oil and other goods from Russia, and this has been seen by many countries as an attempt to weaponise the dollar.
Currently, the Chinese yuan is seen as the primary alternative to the U.S. dollar owing to China’s rising economic power.

Advantages of Reserve Currency

A reserve currency refers to any currency that is widely used in cross-border transactions and is commonly held as reserves by central banks. The currencies of economic superpowers that have usually ended up being used as the global reserve currency.
When a country’s fiat currency enjoys reserve currency status, it gives the country the power to purchase goods and other assets from the rest of the world by simply creating fresh currency out of thin air.
Other currencies such as the British pound and the French franc have served as international reserve currencies in the past. As the economic clout of these countries waned, their currencies faced a similar downfall. This was the case, for example, with the British pound which was gradually replaced by the U.S. dollar as Britain lost its status as a global economic superpower in the first half of the 20th century.
The global reserve currency status of the US Dollar gives it unfair privileges over other countries, thus justifying de-dollarisation attempts by many countries.
Since international transactions carried out in the U.S. dollar are cleared by American banks, this gives the U.S. government significant power to oversee and control these transactions.

Popularity of US Dollar

The U.S. dollar is widely used in international transactions because people actually prefer to use the American currency over others for various economic reasons.
Other currencies are not as popular as the greenback for carrying out international transactions. For example, a recent attempt by India and Russia to carry out trade between the two countries in Indian rupees rather than in U.S. dollars has hit a roadblock because the value of India’s imports from Russia far outweighs its exports to the country. This left Russia with excess rupees in hand which it was unwilling to spend on Indian goods or assets, and led to Russian demands for the settlement of bilateral trade in U.S. dollars.
The global acceptability of the U.S. dollar has primarily been attributed to the popularity of U.S. assets among investors. The U.S. has been running a persistent trade deficit for decades now (the value of its imports has for a long time exceeded the value of its exports to the rest of the world). The excess dollars that the rest of the world accumulates due to the U.S’ trade deficit has been invested in U.S. assets such as in debt securities issued by the US government. The high level of trust that global investors have in the U.S. financial markets, perhaps owing to the ‘rule of law’ in the U.S., is considered to be a major reason why investors prefer to invest in U.S. assets.
China, for instance, which supplies the world with huge volumes of goods and runs a trade surplus, has been trying to make the yuan a reserve currency. However, restrictions placed by the Chinese government on foreign access to China’s financial markets and doubts over ‘rule of law’ in China have adversely affected global demand for the yuan.

Reasons for De-dollarisation

Irresponsible expansion of the money supply can cause the debasement of the currency and eventually threaten its status as a reserve currency.
Expansionary monetary policy adopted by the U.S. Federal Reserve over the decades to argue that this could threaten the U.S. dollar’s status as a global reserve currency. The U.S. central bank usually increases the supply of dollars through various means to tackle economic downturns and also to fund the U.S. government’s expenditures.
However, the U.S. Federal Reserve is not the only central bank in the world that has been debasing its currency by engaging in expansionary monetary policy over several decades. Other countries have also been expanding their respective money supplies to address their domestic economic problems. As long as the U.S. does not debase its currency at a faster pace than other countries, the dollar may manage to hold its value against other currencies and hence its reserve currency status may not come under serious threat.

Way Forward for India: Rupee Invoicing for Foreign Trade

Rupee invoicing became a buzzword post the July 2022 RBI circular that allowed invoicing, payment and settlement of trade (exports/imports) in Indian rupee.
Foreign Trade Policy (FTP) 2023 wants to thrust exports on the wheels of rupee invoicing that proposes both trading partners raising their invoices and settling payments for their transactions on a bilateral basis in rupees. The framework facilitates invoicing of exports and imports in rupee, market-determined exchange rates between currency pairs of the trading partners, and trade settlement via Special Rupee Vostro Account (SRVA).
The benefits of rupee invoicing are manifold, especially during geopolitical unrest and when economic sanctions are levied against India’s major trade partners.
Amongst the benefits, the prominent ones are lowering of transaction costs, a greater degree of price transparency, quick settlement time, promoting international trade, reduction in hedging expenses, reduced cost of holding foreign reserves by the RBI and, most importantly, internationalisation of the rupee.
Analysis shows that invoicing in rupee would be more favourable with trade partners such as Russia, Saudi Arabia, Nigeria and the UAE, where India is a large importer and potential exists for Indian exports as well.
Some of the countries that hold potential for trade settlement in rupee are shown in the Chart.

India’s policy of facilitating trade in rupees has been gaining momentum, with the total number of SRVAs reaching 60 in a span of seven months (Rajya Sabha question on March 14). Eighteen countries have opened SRVAs to facilitate overseas trade in rupee. Of these countries, India recorded a trade deficit with eight — Botswana, Germany, Guyana, Malaysia, Myanmar, Oman, Russia and Singapore — in FY22.

Conclusion:

The effectiveness of rupee trade, however, ultimately depends on whether India is running a net trade deficit or surplus with the participating trading partners, as well as the extent of trading in rupees in comparison to the total bilateral trade.

Angel Tax

Context: In the latest budget, the government has expanded the scope of Angel tax to cover foreign funding. This proposal has created uncertainty among the entrepreneurs.

Angel tax

Angel tax refers to the income tax (30.6 %) imposed on any unlisted company (usually startup enterprises) in receipt of investment which is above the fair market value. Such investment is treated as income from other sources for the tax purpose. This tax was introduced in 2012 in the form of Section 56 (2) of the Income Tax Act to plug money laundering practices.

Earlier, angel tax provisions were applicable only for investments received from resident investors. However, Finance Bill 2023 has extended its applicability to non-resident investors as well.

Issues with Angel tax:

Assessment of Fair market Value: Calculating a startup’s fair market value is subjective and based on negotiations between the startup and investor. Whereas the tax authorities compute the market value based on Discounted cash flow method. The market value arrived under this method tend to be lower than the value agreed by the start-up and investor.
The proposed amendment may deter foreign investors from investing in India and lead some start-ups to consider restructuring their holdings overseas to avoid pressure from concerned foreign investors.

Stringent tax laws like these may result in flipping of start-ups.

Flipping & Reverse flipping:

Flipping refers to an Indian company transforming into a 100% subsidiary of a foreign entity, after it has moved its headquarters overseas, including a transfer of its intellectual property (IP) and others. The same process, but moving back to India, from another country is known as “reverse flipping”.

Virtual Digital Assets

Context: The finance ministry recently placed all the transactions involving virtual digital assets under the Prevention of Money Laundering Act (PMLA) purview.

Definition of VDA under the Finance Act 2022

Any information/code/number/token generated through cryptographic means providing a digital representation of value exchanged with or without consideration. Virtual Digital Assets can be transferred, stored or traded electronically. They can have some inherent value or function as a store of value or Unit of Account or Used for Financial Transaction or Investment.
Non-fungible token.
Any other digital asset as notified by Central Government. Currencies such as Central Bank Digital Currency or any other foreign currency is excluded from this tax.
Centre government has power to exclude any digital asset from the definition of Virtual Digital Asset.

E.g., Bitcoin and other similar Altcoins such as Ethereum, Ripple, Dogecoin etc.

Taxation of Virtual Digital Assets:

Any income arising from the transfer of virtual digital assets will attract tax on the capital gains at the rate of 30%. Additionally, a withholding tax at the rate of 1% will be applicable on the sale of virtual digital assets, if such sale consideration cumulatively exceeds INR 10,000 (approx. USD 130) in any financial year.
Expenses associated with acquiring, holding or selling virtual digital assets are not deductible from the gains arising from their transfer when determining the tax incidence.

E.g., Cost of crypto mining or any other cost cannot be shown as expense to reduce the profit.

Loss from transfer of virtual digital asset cannot be set off against any capital gain made from any other sources like Housing property/shares while paying capital gains tax.
Gifts of virtual digital assets would also be taxable.

VDA under PMLA:

The government brought all the transactions involving crypto assets under the Prevention of Money Laundering Act.
Nature of transactions to be covered under PMLA:

Exchange of virtual digital assets (“VDAs”) with fiat currencies or other VDAs;
Transfer of VDAs;
Provide safekeeping or administration of VDAs or instruments that enable control over VDAs; and
Participate and provide financial services related to an issuer’s offer and sale of VDAs.

All the individuals/instituions involved in the above transactions are required to implement KYC procedure to verify identity of their clients.
They are also required to maintain a record of certain transactions for at least 5 years from the date of each such transaction.
Indian crypto exchanges will have to report suspicious activity to the Financial Intelligence Unit India (FIU-IND).

Fair Lending Practice - Penal Charges in Loan Accounts

Context: Reserve Bank has issued draft guidelines to the financial institutions to ensure reasonableness and transparency in disclosure of penal interest.

Need for guidelines on Penal charges

Penal interest/charges are levied by the lenders on borrowers in case of default. The intent of levying penal charges is essentially to inculcate a sense of credit discipline among borrowers through negative incentives and to ensure fair compensation to the lender. Penal charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest. However, supervisory reviews by RBI had found that some entities were in fact charging excessive rates of penal interest, leading to hardship to the borrowers and disputes.

In the backdrop of raising share of retail lending (Personal loan category had surged to 30% in FY 23, from just 19% eight years ago, making it the largest credit category) RBI felt the need for issuing guidelines on fair lending practices.

The draft guidelines are:

Penalty levied by the financial institutions shall be treated as ‘penal charges’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances. There shall be no capitalisation of penal charges, i.e., no further interest computed on such charges.
The interest rate charged on a loan given by a bank includes appropriate credit risk premium reflecting the credit risk profile of the borrower. So, if the credit risk profile of the borrower undergoes change, banks will be free to alter credit risk premium as per the contracted terms and conditions.
The quantum of penal charges shall be proportional to the defaults.
The penal charges levied on individual borrowers cannot be at a rate higher than a similar charge applicable to corporate borrowers.
The financial institutions shall ensure that there is a clearly laid down Board approved policy on penal charges.

The EU’s new crypto legislation

Context: The Markets in Crypto Assets (MiCA) regulation has been passed by the European Parliament, marking a significant step in bringing the largely unregulated cryptocurrency markets under government regulation.

More on news:

The MiCA will be the world's first comprehensive set of rules for crypto assets and will apply to the 27-country block European Union. After receiving formal approval by member states, the regulation will come into effect, marking a crucial development in the evolution of cryptocurrency markets.

Coverage under MiCA

The MiCA legislation has a broad definition of "cryptoassets," encompassing digital representations of value or rights that use cryptography for security and can be transferred and stored electronically via distributed ledger technology or similar tech.
This definition includes both traditional cryptocurrencies like Bitcoin and Ethereum and newer ones such as stablecoins.
However, MiCA will not regulate cryptoassets that are classified as transferable securities, function like shares or their equivalent, or are already considered financial instruments under existing regulations. Additionally, non-fungible tokens (NFTs) will largely be excluded from MiCA's scope.
The legislation will also not regulate central bank digital currencies issued by the European Central Bank or digital assets issued by national central banks of EU member countries acting in their capacity as monetary authorities, nor will it regulate cryptoassets-related services offered by them.

Depositor Education and Awareness (DEA) Fund

Context: Development of a Centralised Web portal for the Public to Search Unclaimed Deposits

Need of DEA

The deposits remaining unclaimed for 10 years in a bank are transferred to the “Depositor Education and Awareness” (DEA) Fund maintained by the Reserve Bank of India.
Depositors’ protection being an overarching objective, RBI has been taking various measures to ensure that newer deposits do not turn unclaimed and existing unclaimed deposits are returned to the rightful owners or beneficiaries after following due procedure. On the second aspect, banks display the list of unclaimed deposits on their website.
In order to improve and widen the access of depositors / beneficiaries to such data, RBI has decided to develop a web portal to enable search across multiple banks for possible unclaimed deposits based on user inputs. The search results will be enhanced by use of certain AI tools.

The Depositor Education and Awareness Fund Scheme

The fund was created by RBI as per Section 26A of the Banking Regulation Act, 1949.
The amounts to be credited to the Fund by banks shall be deposited in the specified account maintained with the RBI.
The amounts to be credited to the Fund shall be the credit balance in any deposit account maintained with banks which have not been operated upon for ten years or more, or any amount remaining unclaimed for ten years or more, which include:-
- Savings bank deposit accounts
- Fixed or term deposit accounts
- Cumulative/recurring deposit accounts
- Current deposit accounts
- Other deposit accounts in any form or with any name
- Cash credit accounts
- Loan accounts after due appropriation by the banks
- Margin money against issue of Letter of Credit/Guarantee etc., or any security deposit
- Outstanding telegraphic transfers, mail transfers, demand drafts, pay orders, bankers cheques, sundry deposit accounts, vostro accounts, inter-bank clearing adjustments, unadjusted National Electronic Funds Transfer (NEFT) credit balances and other such transitory accounts, unreconciled credit balances on account of Automated Teller Machine (ATM) transactions, etc.
- Undrawn balance amounts remaining in any prepaid card issued by banks but not amounts outstanding against travellers cheques or other similar instruments, which have no maturity period
- Rupee proceeds of foreign currency deposits held by banks after conversion of foreign currency to rupees in accordance with extant foreign exchange regulations and
- Such other amounts as may be specified by the Reserve Bank from time to time.
Any amount payable in foreign currency under an instrument or a transaction, that has remained unclaimed for ten years or more, shall at the time of transfer to the Fund be converted into Indian Rupees at the exchange rate prevailing on that date and in the event of a claim, the Fund shall be liable to refund only the Indian Rupees received by the Fund with respect to such instrument or transaction.
The Fund shall be utilised for promotion of depositors’ interests and for such other purposes which may be necessary for promotion of depositors’ interest as may be specified by the RBI. All expenditure incurred for the promotion of depositors’ education, awareness, interests and other purposes that may be specified by the RBI under Section 26A (4) of the Act, shall be charged to the Fund.

Committee to Administer the Fund

There shall be a Committee to administer and manage the Fund in accordance with the Scheme which shall consist of an ex-officio Chairperson (a Deputy Governor of RBI, nominated by Governor) and not more than six members as decided by the RBI.
The Committee may from time to time lay down a list of activities, the criteria and procedure, etc. for incurring expenditure and achieving the objectives of the Fund.
The Committee shall administer the Fund and shall exercise all powers on behalf of the Fund, including incurring of all expenditure that may be charged to the Fund, and keeping the corpus of the Fund invested.
The expenses of the Committee and other expenses for administration of the Fund shall be charged to the Fund as decided by the Committee.
For facilitating the RBI for determination of the rate of interest payable by the Fund to the depositors, the Committee shall provide to the Reserve Bank such information on the income and expenditure of the Fund as may be required.
For the promotion of depositors’ interests, the Committee may register/recognise from time to time various institutions, organisations or associations, engaged in activities relating to depositor awareness and education, including those proposing to conduct programmes for depositors of banks, organising seminars and symposia for depositors and undertaking projects and research activities relating to these areas.
Institutions, organisations or associations registered/recognized by the Committee may be considered for grant of funds as a grant-in-aid either as one time measure or in stages or by way of reimbursement, depending upon the nature of the activity proposed.

Refunds and Interest

In case of demand from a customer/ depositor whose unclaimed amount/deposit had been transferred to the Fund, banks shall repay the customer/depositor, along with interest if applicable, and lodge a claim for refund from the Fund for an equivalent amount paid to the customer/depositor.
The interest payable, if any, from the Fund on a claim shall accrue only from the date on which the balance in an account was transferred to the Fund to the date of payment to the customer/depositor. No interest shall be payable in respect of amounts refunded from the Fund, in respect of which no interest was payable by the bank to its customer/depositor.
Rate of interest, if any, payable on the principal amount transferred to the Fund shall be specified by the RBI from time to time.

‘PRAVAAH’ (Platform for Regulatory Application, Validation And Authorisation)

Need of PRAVAAH Portal

Various entities are required to obtain licence / authorization to carry out activities regulated by RBI. Further, regulated entities are required to seek certain regulatory approvals from RBI under various statutes / regulations periodically.
Currently, the application and approval processes for the same take place in varied on-line and off-line modes.
The Union Budget for 2023-24 has announced the need to simplify, ease and reduce cost of compliance by financial sector regulators within laid down time limits to decide the applications under various regulations.
It has been decided to develop a secured web based centralised portal named as ‘PRAVAAH’ which will gradually extend to all types of applications made to RBI across all functions.

What is Monetary Policy?

About Monetary Policy

Monetary policy is a set of tools used by a nation's central bank to control the overall money supply and promote economic growth and employ strategies such as revising interest rates and changing bank reserve requirements.
Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.

The Monetary Policy Framework

In May 2016, the RBI Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
Inflation Target: Under Section 45ZA, the Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI), once in five years and notifies it in the Official Gazette.
Accordingly, the Central Government notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent. On March 31, 2021, the Central Government retained the inflation target and the tolerance band for the next 5-year period – April 1, 2021 to March 31, 2026.
Section 45ZB of the RBI Act provides for the constitution of a six-member Monetary Policy Committee (MPC) to determine the policy rate required to achieve the inflation target.

Failure to Maintain Inflation Target

The Central Government has notified the following as the factors that constitute a failure to achieve the inflation target:
- The average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters; or
- The average inflation is less than the lower tolerance level for any three consecutive quarters.
Where the Bank fails to meet the inflation target, it shall set out in a report to the Central Government:
- The reasons for the failure to achieve the inflation target;
- Remedial actions proposed to be taken by the Bank; and
- An estimate of the time period within which the inflation target shall be achieved pursuant to the timely implementation of proposed remedial actions.
The operating framework of monetary policy aims at aligning the operating target – the weighted average call rate (WACR) – with the policy repo rate through proactive liquidity management to facilitate the transmission of repo rate changes through the entire financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.

Monetary Policy Committee

Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. The first such MPC was constituted in September 2016. The present MPC members, as notified by the Central Government in the Official Gazette of October, 2020, are as under:
- Governor of the Reserve Bank of India—Chairperson, ex officio
- Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy—Member, ex officio
- One officer of the Reserve Bank of India to be nominated by the Central Board—Member, ex officio
- Prof. Ashima Goyal, Professor, Indira Gandhi Institute of Development Research —Member
- Prof. Jayanth R. Varma, Professor, Indian Institute of Management, Ahmedabad—Member
- Dr. Shashanka Bhide, Senior Advisor, National Council of Applied Economic Research, Delhi—Member
Last three persons are to be appointed by the central government. This category of appointments must be from “persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy”. (Section 45ZC)
The MPC determines the policy repo rate required to achieve the inflation target.
The MPC is required to meet at least four times in a year. The quorum for the meeting of the MPC is four members.
Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.
Each Member of the Monetary Policy Committee writes a statement specifying the reasons for voting in favour of, or against the proposed resolution.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy.

Repo Rate: The interest rate at which the Reserve Bank provides liquidity under the liquidity adjustment facility (LAF) to all LAF participants against the collateral of government and other approved securities.
Standing Deposit Facility (SDF) Rate: The rate at which the Reserve Bank accepts non collateralized deposits, on an overnight basis, from all LAF participants. The SDF is also a financial stability tool in addition to its role in liquidity management. The SDF rate is placed at 25 basis points below the policy repo rate. With introduction of SDF in April 2022, the SDF rate replaced the fixed reverse repo rate as the floor of the LAF corridor.
Marginal Standing Facility (MSF) Rate: The penal rate at which banks can borrow, on an overnight basis, from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a predefined limit (2 percent). This provides a safety valve against unanticipated liquidity shocks to the banking system. The MSF rate is placed at 25 basis points above the policy repo rate.
Liquidity Adjustment Facility (LAF): The LAF refers to the Reserve Bank’s operations through which it injects/absorbs liquidity into/from the banking system. It consists of overnight as well as term repo/reverse repos (fixed as well as variable rates), SDF and MSF. Apart from LAF, instruments of liquidity management include outright open market operations (OMOs), forex swaps and market stabilisation scheme (MSS).
LAF Corridor: The LAF corridor has the marginal standing facility (MSF) rate as its upper bound (ceiling) and the standing deposit facility (SDF) rate as the lower bound (floor), with the policy repo rate in the middle of the corridor.
Main Liquidity Management Tool: A 14-day term repo/reverse repo auction operation at a variable rate conducted to coincide with the cash reserve ratio (CRR) maintenance cycle is the main liquidity management tool for managing frictional liquidity requirements.
Fine Tuning Operations: The main liquidity operation is supported by fine-tuning operations, overnight and/or longer tenor, to tide over any unanticipated liquidity changes during the reserve maintenance period. In addition, the Reserve Bank conducts, if needed, longer-term variable rate repo/reverse repo auctions of more than 14 days.
Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity from banks against the collateral of eligible government securities under the LAF. Following the introduction of SDF, the fixed rate reverse repo operations will be at the discretion of the RBI for purposes specified from time to time.
Bank Rate: The rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements (cash reserve ratio and statutory liquidity ratio). The Bank Rate is published under Section 49 of the RBI Act, 1934. This rate has been aligned with the MSF rate and changes automatically as and when the MSF rate changes alongside policy repo rate changes.
Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a percent of its net demand and time liabilities (NDTL) as on the last Friday of the second preceding fortnight that the Reserve Bank may notify from time to time in the Official Gazette.
Statutory Liquidity Ratio (SLR): Every bank shall maintain in India assets, the value of which shall not be less than such percentage of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight, as the Reserve Bank may, by notification in the Official Gazette, specify from time to time and such assets shall be maintained as may be specified in such notification (typically in unencumbered government securities, cash and gold).
Open Market Operations (OMOs): These include outright purchase/sale of government securities by the Reserve Bank for injection/absorption of durable liquidity in the banking system.

Monetary Policy Process

The Reserve Bank has notified the Reserve Bank of India Monetary Policy Committee and Monetary Policy Process Regulations, 2016 which consists of the following:

Meeting schedule: The schedule of monetary policy voting/decision meetings for the entire fiscal year is announced in advance.
Meeting notice: Ordinarily, not less than fifteen days’ notice is given to members for meetings of the Committee. Should it be found necessary to convene an emergency meeting, 24 hours’ notice is given to every member to enable him/her to attend, with technology enabled arrangements for even shorter notice period for meetings.
Meeting duration: The duration of monetary policy meetings is as decided by the Committee. The policy resolution is publicly released after the conclusion of the MPC meeting keeping in view the functioning and timing of financial markets.
- The MPC in its meetings reviews the surveys conducted by the Reserve Bank to gauge consumer confidence, households’ inflation expectations, corporate sector performance, credit conditions, the outlook for the industrial, services and infrastructure sectors, and the projections of professional forecasters.
- The MPC also reviews in detail the staff’s macroeconomic projections, and alternative scenarios around various risks to the outlook. Drawing on the above and after extensive discussions on the stance of monetary policy, the MPC adopts a resolution.
The MPC Resolution: The Bank publishes, after the conclusion of every meeting of the MPC, the resolution adopted by the said Committee. The resolution includes the MPC’s decision on the policy repo rate.
Minutes of the MPC meeting: On the 14th day after every meeting of the MPC, the minutes of the proceedings of the MPC are published which include: (a) the resolution adopted by the MPC; (b) the voting of each member on the resolution; and (c) short written statements of individual members justifying the vote, consistent with the provisions of Section 45ZL of the RBI Act. Minutes shall be released at 5 pm on the 14th day from the date of the policy day (or next earliest working day, if a holiday in Mumbai).
The Monetary Policy Report: Once in every six months, the Reserve Bank publishes the Monetary Policy Report containing the following elements:
- Explanation of inflation dynamics in the last six months and the near term inflation outlook.
- Projections of inflation and growth and the balance of risks.
- An assessment of the state of the economy, covering the real economy, financial markets and stability, fiscal situation, and the external sector, which may entail a bearing on monetary policy decisions.
- An updated review of the operating procedure of monetary policy.
- An assessment of projection performance.

Monetary Policy Stance

The MPC indicates its broader policy approach by guiding the markets with policy stances.

Accommodative: means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out. The central bank typically adopts an accommodative policy when growth needs policy support and inflation is not the immediate concern.
Neutral: suggests that the central bank can either cut rate or increase rate. This stance is typically adopted when the policy priority is equal to both inflation and growth. During neutral policy, the central bank doesn’t commit to hiking rates or cuts. The interest rate can move to either side depending on incoming data. The guidance indicates that the market can expect a rate action on either way at any point.
Hawkish: indicates that the central bank’s top priority is to keep the inflation low. During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand. A hawkish policy also indicates tight monetary policy. A rate cut is nearly certain during such a period. When the central bank increases rates or 'tightens' the monetary policy, banks too increase their rate of interest on loans to end borrowers which, in turn, curbs demand in the financial system.
Calibrated tightening: means during the current rate cycle, a cut in the repo rate is off the table. But, the rate hike will happen in a calibrated manner. This means the central bank may not go for a rate increase in every policy meeting but the overall policy stance is tilted towards a rate hike. This can happen outside the policy meetings as well if the situation warrants it.

NPCI’s circular on levy charges

About NPCI

National Payments Corporation of India (NPCI), an umbrella organisation for operating retail payments and settlement systems in India, is an initiative of Reserve Bank of India (RBI) and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007, for creating a robust Payment & Settlement Infrastructure in India.
Considering the utility nature of the objects of NPCI, it has been incorporated as a “Not for Profit” Company under the provisions of Section 25 of Companies Act 1956 (now Section 8 of Companies Act 2013), with an intention to provide infrastructure to the entire Banking system in India for physical as well as electronic payment and settlement systems.
NPCI is focused on bringing innovations in the retail payment systems through the use of technology for achieving greater efficiency in operations & widening the reach of payment systems.
The ten core promoter banks are State Bank of India, Punjab National Bank, Canara Bank, Bank of Baroda, Union Bank of India, Bank of India, ICICI Bank Limited, HDFC Bank Limited, Citibank N. A. and HSBC.
In 2016 the shareholding was broad-based to 56 member banks to include more banks representing all sectors.
In 2020, new entities regulated by RBI were inducted, consisting of Payment Service Operators, payment banks, Small Finance Banks, etc.
The shares were allotted pursuant to issuance of equity shares on private placement basis in compliance to the applicable provisions of the Companies Act, 2013.

What is UPI?

UPI is an instant real-time payment system developed by National Payments Corporation of India (NPCI)
The mobile-based fast payment system is built over the IMPS infrastructure.
Features:
- The payments can be made round-the-clock and in real time.
- It eliminates the risk of sharing bank account details by the remitter as customers are not required to enter the details such as Card no, account number, IFSC etc.
- UPI supports both Person-to-Person (P2P) and Person-to-Merchant (P2M) payments and it also enables a user to send or receive money.
- It enables the use of a single mobile application for accessing different bank accounts.
- Transactions are carried out through mobile devices with two factor authentication using device binding and a UPI PIN as security.
- Registration of Beneficiary is not required for transferring funds through UPI as the fund would be transferred based on using a Virtual Payment Address (VPA) created by the customer.

The Circular on Levy Charges

National Payments Corporation of India (NPCI), which governs UPI - intimated banks and payment service providers that they can now levy charges on merchant transactions made through Prepaid Instrument wallets using UPI.
- For using prepaid payment instruments (PPIs) such as gift cards, wallets etc for transactions on UPI, an interchange fee of up to 1.1% has been levied from April 1, 2023.
It also issued a clarification stating that normal bank-to-bank UPI transactions will not be charged and that customers will not have to pay for transactions made via PPI on UPI.
New interchange charges are only applicable for Prepaid Payment Instruments’ (PPI) merchant transactions.
The interchange fee, generally associated with card payments to cover the transaction cost, has now brought PPI wallets also under its fold.

What are PPIs?

Prepaid Payment Instruments (PPIs) are payment methods that can be used to purchase goods and services and send/receive money by using the stored value in the wallet.
Users have to pre-load the wallet with a desired amount.
The amount can be loaded/reloaded against cash or through debit to bank account, or by using credit/debit cards, UPI, or any other approved payment method in India. PPIs can only be used in Indian rupees.
PPIs can be in the form of mobile wallets, physical smart cards, secure tokens, vouchers, or any other method that allows access to prepaid funds.

What is PPI interoperability?

Previously, to use PPI at any merchant, it was necessary that the concerned merchant was engaged directly by the specific PPI issuer (specific network). All PPIs with which the merchant did not have a direct tie-up would get rejected.
The most prevalent form of PPI used in the country is the mobile wallet, and this restriction meant that customers of one specific mobile wallet could spend the money in the wallet only at specific merchant locations which were directly tied up with the same PPI wallet provider.
For example, if you had a Paytm or Mobikwik wallet, you could only use it at merchants that accepted Paytm or Mobikwik QR codes.
To overcome this limitation of PPIs, the RBI has mandated interoperability among different PPI issuers.
Subsequently, PPI issuers tied-up with NPCI for issuing
- interoperable RuPay PPI cards
- creating interoperable wallets on UPI rails.
Prepaid instruments in the form of wallets can now be linked to UPI, thus creating interoperable wallets on UPI rails.

How does PPI interoperability through UPI work?

After linking one’s PPI wallet to UPI, customers can transact using Scan and Pay on all UPI interoperable QR codes. This will enable the use of PPI wallets at all merchant locations.
The user can also send/receive money to any other wallet user.
Similarly, a merchant with any UPI QR code can now accept payments from any PPI issuer or mobile wallet.
PPI on UPI will speed up the growth of merchant transactions in rural areas and further deepen digital financial inclusion by catering to use cases such as healthcare, transit, education, utility bills, etc.

Do merchants have to pay for accepting wallet transactions on UPI?

The PPI enabled merchants were already paying charges to the PPI issuer for acceptance of mobile wallets or prepaid cards. Now the charges are aligned at a network level with some standardisation. However, each merchant can work with their preferred acquiring entity.
Now, for using prepaid payment instruments (PPIs) such as gift cards, wallets etc for transactions on UPI, an interchange fee of up to 1.1% has been levied from April 1, 2023.
- The charges are applicable if the transaction is more than ₹2,000.
- If you are a merchant and accepting UPI payments from a customer’s bank account, then there are no charges applicable.
- Charges are applicable only if you have accepted or consented for the transactions made using PPI Wallet.

Are there any charges to be paid by consumers holding wallets for PPI on UPI transactions?

Officially there are no charges to be paid by the customer. However, merchants may pass on the additional burden to customers by way of price increase or some other means.

PPF, Sukanya Samriddhi interest rate hike unlikely

Context: Investors in the popular small saving schemes Public Provident Fund (PPF) and Sukanya Samriddhi Account (SSA), whose rates have not been hiked since January 2019, are unlikely to get higher returns anytime soon.

Why:

This is because the government is no longer in complete agreement with the Shyamala Gopinath Committee formula adopted in April 2016 to reset small savings interest rates every quarter in line with the prevailing yields on government bonds of comparable tenures.

Sukanya Samriddhi Account Scheme

What: It is a small saving scheme for the girl child launched under Beti Bachao Beti Padao.
When: launched on 22 January 2015 in Panipat, Haryana by Prime Minister Narendra Modi.
Administered under: Ministry of Finance
Objective: aimed at the betterment of the girl child in the country by abolishing sex determination, gender discrimination, protection of girls, and higher participation of girls in education and other fields.
Basic provisions of the scheme:
- Minimum deposit ₹ 250/- Maximum deposit ₹ 1.5 Lakh in a financial year.
- Account can be opened in the name of a girl child till she attains the age of 10 years.
- Only one account can be opened in the name of a girl child.
- Account can be opened in Post offices and in authorised banks.
- Withdrawal shall be allowed for the purpose of higher education of the Account holder to meet education expenses.
- The account can be prematurely closed in case of marriage of girl child after her attaining the age of 18 years.
- The account can be transferred anywhere in India from one Post office/Bank to another.
- The account shall mature on completion of a period of 21 years from the date of opening of account.
- The rate of interest is decided by the government and is determined on a quarterly basis.
Peripheral benefits of the scheme:
- Deposit qualifies for deduction under Sec.80-C of Income Tax Act.
- Interest earned in the account is free from Income Tax under Section -10 of Income Tax Act.

Suggestions of Shyamala Gopinath Committee

The committee had suggested that the interest rates of different schemes should be 25bps-100bps higher than the yields of the government bonds of similar maturity.

Source: The Hindu & PIB