Evolution of Central Banking in India (by Dr. Rakesh Mohan, Deputy Governor at the se inar organi!

ed by the "ondon #$hool of E$ono i$s and the %ational Institute of Bank Manage ent at Mu bai on &anuary '(, '))*+ I ust $ongratulate the organi!ers for $hoosing this i portant topi$ for deliberation in this se inar. I have great pleasure in entioning that the the e of the Report on Curren$y and ,inan$e - '))(-)., prepared by the staff of the Reserve Bank of India (RBI+, is also that of evolution of Central Banking in India (RBI, ')).a+. In going through the pro$ess of $o pilation of the Report, I have found the evolutionary pro$ess of $entral banking all over the /orld and also that in India to be very interesting and infor ative. 0he ost striking feature of $entral bank fun$tioning both a$ross ti e and over $ountries in a $onte poraneous anner, is not ho/ si ilar their fun$tions are or have been, but ho/ heterogeneous they are and ho/ their fun$tions have $onstantly evolved over the $hanging ti es. My interest in tra$king the evolution of $entral banking in India has also been triggered by the re$ent publi$ation of the history of the Reserve Bank of India in three volu es, $overing the period 123. - 1241 (RBI, ')).b+. I. Global Evolution of Central Banking Evolution of $entral banking is essentially a t/entieth $entury pheno enon as there /ere only about a do!en $entral banks in the /orld at the turn of the t/entieth $entury. In $ontrast, at present, there are nearly 1*) $entral banks. 0his is not surprising sin$e the need for $entral banks obviously e erged as banking be$a e ore $o ple5, /hile be$o ing an in$reasingly i portant part of the e$ono y over ti e. 0he any vi$issitudes e5perien$ed by banks and their depositors inevitably led to $ries for their regulation. #e$ond, $entral banks are essentially a nation state pheno enon, and hen$e proliferated as nation states the selves e erged and ultiplied6 again a t/entieth $entury pheno enon. 0hird, it is useful to re$all so e of the reasons for the origin of $entral banks6 to issue $urren$y7 to be a banker and lender to the govern ent6 to regulate and supervise the banks and finan$ial entities6 and to serve as a lender-of-last-resort. 0his is ironi$ sin$e u$h of the $urrent professional thinking is that a $entral bank should be independent of govern ent, should no longer be a debt anager of the govern ent, and should not regulate or supervise $o er$ial banks. 0he ne/ ob8e$tive fun$tion assigned to the $entral bank is to fo$us on pri$e stability, /ith finan$ial stability as an additional ob8e$tive in so e $ases. 0his is perhaps not surprising sin$e pri$e stability /as histori$ally a$hieved, along /ith preservation of $urren$y value, through the gold standard, and later through the dollar an$hor and its relation to gold. 0he /orld lost its onetary an$hor on 9ugust 1., 12:1 /hen the ;# de$ided to delink the dollar fro gold, and has been floundering ever sin$e in sear$h of a ne/ an$hor. 9fter the $onvulsions of the 12*)s and 12:)s, ainly related to the finan$ing of the <ietna /ar, the e5pansion of /orld li=uidity, and the ensuing so e/hat enduring inflation, along /ith "atin 9 eri$an fis$al and onetary e5pansion, the ne/ holy grail is independen$e of the $entral bank, a $on$ept that is be$o ing al ost synony ous /ith inflation targeting. 9nd here, though I a too ne/ to $entral banking to really offer a definitive vie/, I have to ad it to a $ertain skepti$is related to the $urrent fashion a ong $entral bankers. 0/o pertinent =uestions are natural to be asked. ,irst, /hy is it so obvious that $entral banks should abandon their >parents?, the sovereign govern ent@

Ane =ui$k e5planation $ould be that the $entral banks have >$o e-of-age? in re$ent years. But then, so e instan$es like the $ase of t/o $urren$ies in Ira= in the 122)s and that of the Bank of &apan in re$ent years provide a $ontrary vie/ to the >$o e-of-age? hypothesis (Bing, '))(+. #e$ond, is it really the $ase that supervision and regulation of banks by the $entral bank leads to $onfli$t of interest@ In $onsideration of this $onfli$t, the ,inan$ial #ervi$es 9uthority /as established in the ;B in '))), and a nu ber of $ountries have follo/ed suit. Chat I /ould like to do today is to e5plore so e of these issues as they relate to India at the present ti e. II. The Historical Antecedents of Central Banking in India In India, the efforts to establish a banking institution /ith $entral banking $hara$ter dates ba$k to the late 14th $entury. 0he Governor of Bengal in British India re$o ended the establish ent of a General Bank in Bengal and Bihar. 0he Bank /as set up in 1::3 but it /as short-lived. It /as in the early ')th $entury that, $onse=uent to the re$o endations of the Cha berlain Co ission (121(+ proposing the a alga ation of the three Dresiden$y Banks, the I perial Bank of India /as for ed in 12'1 to additionally $arry out the fun$tions of $entral banking along /ith $o er$ial banking. In 12'*, the Royal Co ission on Indian Curren$y and ,inan$e (Eilton Foung Co ission+ re$o ended that the di$hoto y of fun$tions and divisions of responsibilities for $ontrol of $urren$y and $redit should be ended. 0he Co ission suggested the establish ent of a $entral bank to be $alled the Reserve Bank of India, /hose separate e5isten$e /as $onsidered ne$essary for aug enting banking fa$ilities throughout the $ountry. 0he Bill to establish the RBI /as introdu$ed in &anuary 12': in the "egislative 9sse bly, but it /as dropped due to differen$es in vie/s regarding o/nership, $onstitution and $o position of its Board of Dire$tors. ,inally, a fresh Bill /as introdu$ed in 1233 and passed in 123(. 0he RBI 9$t $a e into for$e on &anuary 1, 123.. 0he RBI /as inaugurated on 9pril 1, 123. as a shareholders? institution and the 9$t provided for the appoint ent by the Central Govern ent of the Governor and t/o Deputy Governors. 0he RBI /as nationali!ed on &anuary 1, 12(2 in ter s of the Reserve Bank of India (0ransfer to Dubli$ A/nership+ 9$t, 12(4 (RBI, ')).b+. 0he ain fun$tions of the RBI, as laid do/n in the statutes are - a+ issue of $urren$y, b+ banker to Govern ent, in$luding the fun$tion of debt anage ent, and $+ banker to other banks. 0he Drea ble to the RBI 9$t laid out the ob8e$tives as Gto regulate the issue of bank notes and the keeping of reserves /ith a vie/ to se$uring onetary stability in India and generally to operate the $urren$y and $redit syste of the $ountry to its advantage.G ;nusually, and unlike ost $entral banks the RBI /as spe$ifi$ally entrusted /ith an i portant pro otional role sin$e its in$eption to finan$e agri$ultural operations and arketing of $rops. In fa$t, the 9gri$ultural Credit Depart ent /as $reated si ultaneously /ith the establish ent of the RBI in 123.. 0he RBI, as a $entral bank, has al/ays perfor ed the fun$tion of aintaining the e5ternal value of the rupee. Eistori$ally, the rupee /as linked /ith pound sterling, /hi$h $ontinued even after the establish ent of the RBI. It /as only in late #epte ber 12:. that the rupee /as delinked fro pound sterling and the value /as deter ined /ith referen$e to a basket of $urren$ies until 1221. 0he e5$hange rate regi e, soon thereafter, transited fro a basket-linked anaged float to a arket-based syste in Mar$h 1223, after a short e5peri ent /ith a dual e5$hange rate regi e bet/een Mar$h 122' and ,ebruary 1223. Drior to the #e$ond Corld Car, India /as a net debtor $ountry and the

British introdu$ed e5$hange $ontrols to $onserve foreign e5$hange. E5$hange Control /as introdu$ed in India on #epte ber 3, 1232 on the outbreak of the #e$ond Corld Car by virtue of the e ergen$y po/ers derived under the finan$ial provisions of the Defen$e of India Rules, ainly to $onserve the non-sterling area $urren$ies and utili!e the for essential purposes. Even after the Car, the $ontrols $ontinued ainly to ensure the ost prudent use of the foreign e5$hange resour$es. Eo/ever, the vast a$$u ulation of sterling balan$es during the #e$ond Corld Car provided an opportunity for repatriation of the sterling debt, an initiative /hi$h $a e at the behest of the RBI. 0he RBI?s responsibility as bankers? bank /as essentially t/o-fold. ,irst, it a$ted as a sour$e of reserves to the banking syste and served as the lender of last resort in an e ergen$y. 0he se$ond, and ore i portant responsibility, /as to ensure that the banks /ere established and run on sound lines /ith the e phasis on prote$tion of depositors? interest. 9 banking $risis in 1213 revealed a8or /eaknesses in the banking syste , su$h as, aintenan$e of lo/ reserves and large volu es of unse$ured advan$es. 0hus, regulation of the banking syste /as $onsidered essential to aintain stability in the e$ono y. In the initial years, banks /ere governed by the Indian Co panies 9$t, 1213 follo/ed by ad ho$ ena$t ents, su$h as the Banking Co panies (Inspe$tion+ Ardinan$e, 12(* and the Banking Co panies (Restri$tion of Bran$hes+ 9$t, 12(*. 9s dissatisfa$tion /ith bank failures in$reased the need for a statutory bank regulator be$a e ore pressing. Conse=uently, a spe$ial legislation $alled the Banking Co panies 9$t /as passed in Mar$h 12(2, /hi$h /as rena ed as the Banking Regulation 9$t in Mar$h 12**. III. Development ole of the BI 9s in any developing $ountries, the $entral bank is seen as a key institution in bringing about develop ent and gro/th in the e$ono y. In the initial years of the RBI before independen$e, the banking net/ork /as thinly spread and seg ented. ,oreign banks served foreign fir s, the British ar y and the $ivil servi$e. Do esti$HIndian banks /ere linked to do esti$ business groups and anaging agen$ies, and pri arily did business /ith their o/n groups. 0he $overage of institutional lending in rural areas /as poor despite the $ooperative ove ent. Averall finan$ial inter ediation /as /eak. In an agrarian e$ono y, /here ore than three-fourth of the population lived in the rural areas and $ontributed ore than half of GDD, a $onstant and natural $on$ern /as agri$ultural $redit. 0herefore, al ost every fe/ years a $o ittee /as $onstituted to e5a ine the rural $redit e$hanis . 0here has perhaps been one $o ittee every t/o or three years for over a hundred years. 9 $lear ob8e$tive of the develop ent role of the RBI /as to raise the savings ratio to enable the higher invest ent ne$essary for gro/th, in the absen$e of effi$ient finan$ial inter ediation and of a /ell developed $apital arket. 0he vie/ /as that the poor /ere not $apable of saving and, given the s all proportion of the population that /as /ell off, the only /ay to ki$k start the savings and invest ent pro$ess in the $ountry /as for govern ent to perfor both fun$tions. 0hus the RBI /as seen to have a legiti ate role to assist the govern ent in starting up several spe$iali!ed finan$ial institutions in the agri$ultural and industrial se$tors, and to /iden the fa$ilities for ter finan$e and for fa$ilitating the institutionalisation of savings. 9 spe$ial need /as felt for a$$elerating industrial invest ent, parti$ularly /ith the laun$hing of the #e$ond ,ive Fear Dlan in 12.*. Aver ti e, various ter lending industrial finan$e institutions /ere established

/ith varying degrees of RBI involve ent6 the Industrial ,inan$e Corporation of India (I,CI+, #tate ,inan$ial Corporations (#,Cs+, Industrial Develop ent Bank of India (IDBI+ and the Industrial Credit and Invest ent Corporation of India (ICICI+. 0he traditional $on$ern /ith agri$ultural $redit $ontinued and the 9gri$ulture ,inan$e Corporation /as established in 12*3, follo/ed by its transfor ation into the %ational Bank for 9gri$ulture and Rural Develop ent in 124' for e5tending refinan$e for short, ediu and long ter finan$e for agri$ulture. 0he ;nit 0rust of India /as established in 12*( to obili!e resour$es fro the /ider publi$ and to provide an opportunity for retail investors to invest in the $apital arket, thereby also aiding $apital arket develop ent. 0he %ational Eousing Bank /as set up in the late 124)s to develop housing finan$e and the Infrastru$ture Develop ent ,inan$e Co pany (ID,C+ in the late 122)s for infrastru$ture finan$e. 0he Reserve Bank also a$tively pro oted finan$ial institutions to help in developing the Govern ent se$urities arket. 0he Dis$ount and ,inan$e Eouse of India (D,EI+ /as set up in 12447 pri ary dealers /ere pro oted in the late 122)s7 and the Clearing Corporation of India /as in$orporated in '))1 to upgrade the finan$ial infrastru$ture in respe$t of $learing and settle ent of debt instru ents and foreign e5$hange transa$tions. More re$ently, the Board for Regulation and #upervision of Day ent and #ettle ent #yste has been $onstituted in '))., and the Banking Codes and #tandards Board of India in '))* to develop a $o prehensive $ode of $ondu$t for fair treat ent of bank $usto ers. 0he RBI has been $ontinuously involved in setting up or supporting these institutions /ith varying degrees of involve ent, in$luding e=uity $ontributions and e5tension of lines of $redit. 0hus, the develop ental role of the RBI has spanned all the de$ades sin$e independen$e and is =uite different fro $entral banks in developed $ountries. 9lthough the Reserve Bank /as a$tively involved in setting up any of these institutions, the general pra$ti$e has been to hive the off as they $a e of age, or if a per$eption arose of potential $onfli$t of interest. 0here $an be little doubt that the establish ent of these institutions has helped finan$ial develop ent in the $ountry greatly, even though so e of the have been less than su$$essful in their fun$tioning. It $an be argued, of $ourse, that si ilar institutional develop ent $ould have taken pla$e through private se$tor efforts or by the Govern ent. 0he availability of finan$ial se$tor e5pertise in the Reserve Bank, ho/ever, /as instru ental in these tasks being perfor ed over ti e by the Reserve Bank. E!pansion of Banking In the initial years of the RBI, $onsiderable progress /as ade in e5tending the banking syste but there /as $ontinuing $on$ern about the overall a$$essibility of banking to the needy. In ter s of $overage, any rural and se i-urban areas /ere yet to be $overed by banking servi$es. 0he transfor ation of the I perial Bank of India into the #tate Bank of India in &uly 12.. /as ainly otivated by the desire to e5tend bran$hes a$ross the $ountry to sti ulate banking a$tivity. It /as in $ontinuation of the sa e poli$y to serve the needs of the developing e$ono y that 1( large banks /ere nationali!ed in 12*2 follo/ed by si5 ore in 124). 0he nationali!ation of banks, ainly atte pted to align banking a$tivities /ith national $on$erns and nor s, as it /as per$eived that the private banks neither understood so$ial responsibilities nor observed so$ial obligations. 0he general in$lination in the 12.)s, 12*)s and 12:)s /as essentially to get Govern ent to be$o e a$tive in e$ono i$ a$tivities /here it /as felt that the private se$tor /as not able or /illing to perfor a$tively. 9s a result of nationali!ation, the total nu ber of bran$hes

rose fro 4,'*' in 12*2 - to *),'') in 1221 and those in rural areas fro 1,433 to 3.,')*. 0he in$reased net/ork of bran$hes $ertainly led to a large e5pansion of rural $redit. 0his di ension of nationalisation and e5pansion had its i pa$t on the fun$tioning and /orking of the RBI. Despite su$h vast e5pansion, it is interesting that /e still have $on$ern /ith finan$ial in$lusion today. Development of the "a#ments $#stem 0he develop ent of a pay ents syste is one develop ent role that is $o on to ost $entral banks. It is /ell re$ogni!ed that an effi$ient pay ent and settle ent syste is essential for a /ell fun$tioning odern finan$ial syste . 0herefore, in re$ent years, banks have been aking efforts to upgrade pay ents and settle ent syste s utili!ing the latest te$hnology. Ane of the $hara$teristi$ features of the Indian e$ono y, histori$ally, has been the /idespread use of $ash in the settle ent of ost finan$ial transa$tions. Chile this has been the trend for several years, it is note/orthy that India had pioneered the use of non-$ash based pay ent syste s long ago, /hi$h had established the selves as strong instru ents for the $ondu$t of trade and business. 0he ost i portant for of $redit instru ent that evolved in India /as ter ed as >Eundis? and their use /as reportedly kno/n sin$e the t/elfth $entury. Eundis /ere used as instru ents of re ittan$e, $redit and trade transa$tions. In odern ti es, /ith the develop ent of the banking syste and higher turnover in the volu e of $he=ues, the need for an organi!ed $he=ue $learing syste e erged. In India, $learing asso$iations /ere for ed in the Dresiden$y to/ns in the nineteenth $entury and the final settle ent bet/een e ber banks /as effe$ted by eans of $he=ues dra/n on the Dresiden$y Banks. Cith the setting up of the I perial Bank in 12'1, settle ent /as done through $he=ues dra/n on that bank. 9fter the establish ent of the RBI in 123., the Clearing Eouses in the Dresiden$y to/ns /ere taken over by the RBI, and $ontinued for ore than five de$ades. In re$ognition of the i portan$e of pay ent and settle ent syste s, the RBI had taken upon itself the task of setting up a safe, effi$ient and robust pay ent and settle ent syste for the $ountry for ore than a de$ade no/. In the re$ent past, the RBI has been pla$ing e phasis on refor s in the area of pay ent and settle ent syste . It /as /ith this ob8e$tive that the Real 0i e Gross #ettle ent (R0G#+ syste /as planned, /hi$h has been operationalised in Mar$h '))(. 0he syste , on$e fully operational, in its present for , /ould take $are of all inter-bank transa$tions and other features /ould be added soon. In vie/ of the positive response to refor s in the finan$ial se$tor and the banking seg ent also $o ing of age, the RBI has no/ taken the poli$y perspe$tive of igrating a/ay fro the a$tual anage ent of retail pay ent and settle ent syste s. 0hus, for a fe/ years no/, the task of setting up ne/ MICR based $he=ue pro$essing $enters has been delegated to the $o er$ial banks. 0his approa$h has yielded good results and the RBI no/ envisions the nor al pro$essing fun$tions to be anaged and operated by professional organi!ations, /hi$h $ould be $onstituted through parti$ipation of $o er$ial banks. 0his /ould be appli$able to the $learing houses as /ell, /hi$h /ill perfor the $learing a$tivities, but the settle ent fun$tion /ill $ontinue to rest /ith the RBI. 9 beginning has been ade in the for of the operations perfor ed by the Clearing Corporation of India "td. for effe$ting the $learing pro$esses related to oney,

govern ent se$urities and foreign e5$hange arkets. ;nder this arrange ent, the RBI /ill $ontinue to have regulatory oversight over su$h fun$tions /ithout a$tually a$ting as the servi$e provider. 0he R0G#, /hi$h provide for funds transfers a$ross parti$ipants in ele$troni$ ode /ith redu$ed risk, /ill $ontinue to be operated by the RBI. I<. Relationship of the RBI /ith the Govern ent 0he RBI is a banker to the Central Govern ent statutorily and to the #tate Govern ents by virtue of spe$ifi$ agree ents /ith ea$h of the . 0he loss of autono y of the RBI that took pla$e in early de$ades /as not be$ause of any $ons$ious de$ision based on the $urrently prevalent thinking on the relationship bet/een $entral banks and the Govern ent, but rather as a $onse=uen$e of overall e$ono i$ poli$y then prevailing regarding the appropriate do inant role of the Govern ent in the e$ono y as a /hole. 0hus, it is useful to revie/ the relationship of the Reserve Bank /ith the Govern ent as it has evolved over ti e. The %onetar# &iscal Interface It is $o on for $entral banks in developing $ountries to a$t as debt anagers of their respe$tive govern ents. Central Banks have typi$ally finan$ed govern ents through onetisation as and /hen the need arose for e5pansionary fis$al poli$y /hi$h has been often in developing $ountries. Car finan$ing through oneti!ation has also been the nor for developed $ountries. #u$h finan$ing has nor ally had predi$table inflationary $onse=uen$es for the e$ono y. 0he Indian e5perien$e has been no different and e5pansionary fis$al poli$y /as indeed finan$ed by resort to auto ati$ oneti!ation, a$$o panied by finan$ial repression and effe$tive loss of $entral bank autono y /ith respe$t to onetary poli$y. In 12.1, /ith the onset of e$ono i$ planning, the fun$tions of the RBI be$a e ore diversified. 9s the $entral bank of a typi$al developing $ountry e an$ipated fro $enturies old $olonial rule, the RBI had to parti$ipate in the nation building pro$ess. ,is$al poli$y assu ed the responsibility of triggering a pro$ess of e$ono i$ gro/th through large publi$ invest ent, fa$ilitated by a$$o odative onetary and $ondu$ive debt anage ent poli$ies. 0he RBI played a $ru$ial role in bridging the resour$e gap of the Govern ent in plan finan$ing by onetising govern ent debt and aintaining interest rates at artifi$ially lo/ levels for govern ent se$urities to redu$e the $ost of govern ent borro/ing. 0he provisions of the Reserve Bank of India 9$t, 123( authori!es the RBI to grant advan$es to the Govern ent, repayable not later than three onths fro the date of advan$e. 0hese advan$es, in prin$iple, /ere to bridge the te porary is at$hes in the Govern ent?s re$eipt and e5penditure and /ere ainly intended as tools for Govern ent?s $ash anage ent. Eo/ever, in pra$ti$e, the tool of short-ter finan$ing be$a e a per anent sour$e of funds for the Govern ent through auto ati$ $reation of ad ho$ 0reasury bills /henever Govern ent?s balan$es /ith the RBI fell belo/ the ini u stipulated balan$e. 0his auto ati$ oneti!ation led to the RBI?s loss of $ontrol over $reation of reserve oney. In addition, the RBI also $reated additional ad ho$ 0reasury bills /henever funds /ere re=uired by the Govern ent. 9s there /as unbridled e5pansion of fis$al defi$its and the Govern ent /as not in a position to redee the ad ho$ 0reasury bills, the RBI /as saddled /ith a large volu e of these bills $onstituting a substantial $o ponent of oneti!ed defi$it. 0his pro$ess $ontinued fro the 12.)s to the 122)s.

By the end of the 124)s a fis$al- onetary-inflation ne5us /as in$reasingly be$o ing evident /hereby e5$essive onetary e5pansion on a$$ount of oneti!ation of fis$al defi$it fuelled inflation. 0he RBI endeavored to restri$t the onetary i pa$t of budgetary i balan$es by raising the re=uired reserve ratios to be aintained by banks. 9s the gro/th of pre-e pted resour$es /as inade=uate to eet the Govern ent?s re=uire ent, it had to perfor$e borro/ funds fro outside the $aptive arket through postal savings and provident funds, by offering substantial fis$al in$entives and at ad inistered lo/ rates of interest. 0hus, the e$ono y /as pushed into the throes of finan$ial repression. 0he logi$al =uestion that follo/s is /hether the e5perien$e of fis$al do inan$e over onetary poli$y /ould have been different if there had been separation of debt anage ent fro onetary anage ent in India@ Ar, /ere /e served better /ith both the fun$tions residing in the Reserve Bank@ Chat has really happened is that there /as a signifi$ant $hange in thinking regarding overall e$ono i$ poli$y during the early 122)s, arguing for a redu$ed dire$t role of the Govern ent in the e$ono y. 9 $ons$ious vie/ e erged in favour of fis$al stabilisation and redu$tion of fis$al defi$its ai ed at eli inating the do inan$e of fis$al poli$y over onetary poli$y through the prior pra$ti$e of fis$al defi$its being finan$ed by auto ati$ oneti!ation. It is this overall e$ono i$ poli$y transfor ation that has provided greater autono y to onetary poli$y aking in the 122)s. In pursuan$e of the finan$ial se$tor refor s undertaken in 1221, despite the proa$tive fis$al $o pression and efforts ade by the RBI in oderating oney supply during the early part of the 122)s, the $ontinuan$e of the ad ho$ 0reasury bills i plied that there $ould not be an i ediate $he$k on the oneti!ed defi$it. In order to $he$k this unbridled auto ati$ oneti!ation of fis$al defi$its, the ,irst #upple ental 9gree ent bet/een the RBI and the Govern ent of India on #epte ber 2, 122( set out a syste of li its for $reation of ad ho$ 0reasury bills during the three-year period ending Mar$h 122:. In pursuan$e of the #e$ond #upple ental 9gree ent bet/een the RBI and the Govern ent of India on Mar$h *, 122:, the ad ho$ 0reasury bills /ere $o pletely phased out by $onverting the outstanding a ount into spe$ial undated se$urities and /ere repla$ed by a syste of Cay and Means 9dvan$es. 0he parti$ipation by the RBI in pri ary au$tions of the Govern ent has also been dis$ontinued /ith effe$t fro 9pril 1, '))* under the provisions of ,is$al Responsibility and Budget Manage ent 9$t, '))3 (,RBM+. Ather related easures that have been initiated sin$e 1221 are deregulation of interest rates and lo/ering of statutory ratios. 0he Indian e$ono y has ade $onsiderable progress in developing its finan$ial arkets, espe$ially the govern ent se$urities arket sin$e 1221. ,urther ore, fis$al do inan$e in onetary poli$y for ulation has signifi$antly redu$ed in re$ent years. Cith the onset of a fis$al $onsolidation pro$ess, /ithdra/al of the RBI fro the pri ary arket of Govern ent se$urities and e5pe$ted legislative $hanges per itting a redu$tion in the statutory ini u #tatutory "i=uidity Ratio, fis$al do inan$e /ould be further diluted. 9ll of these $hanges took pla$e despite the $ontinuation of debt anage ent by the Reserve Bank. 0hus, one $an argue that effe$tive separation of onetary poli$y fro debt anage ent is ore a $onse=uen$e of overall e$ono i$ poli$y thinking rather than adheren$e to a parti$ular vie/ on institutional arrange ents. 0he $ore issue of the $onfli$t of interest bet/een onetary poli$y and publi$ debt anage ent lies in the fa$t that /hile the ob8e$tive of ini i!ing arket borro/ing $ost

for the Govern ent generates pressures for keeping interest rates lo/, $o pulsions of onetary poli$y a idst rising inflation e5pe$tations ay ne$essitate a tighter onetary poli$y stan$e. 0herefore, the argu ent in favor of separating debt anage ent fro onetary poli$y rests on the availability of effe$tive autono y of the $entral bank, so that it is able to $ondu$t a $o pletely independent onetary poli$y even in the fa$e of an e5pansionary fis$al stan$e of the govern ent. But is this a realisti$ possibility@ If there is an understanding a ongst poli$y akers that e5pansionary fis$al poli$y that is finan$ed by oneti!ation leads to undesirable results /ould su$h a poli$y be pursued@ 0he Indian e5perien$e has itself sho/n that as su$h realisation took pla$e in the 122)s the poli$y response /as to arrive at poli$y $onventions bet/een the Govern ent and the Reserve Bank that enabled the pra$ti$e of independent onetary poli$y, despite debt anage ent $ontinuing to be housed in the RBI. In theory, separation bet/een the t/o fun$tions /ould perhaps enhan$e the effi$ien$y in onetary poli$y for ulation and debt anage ent, but the debate in the Indian $onte5t needs to re$ogni!e $ertain key dyna i$s of the fis$al- onetary ne5us. ,irst, in India, the 8oint poli$y initiatives by the Govern ent and the RBI have fa$ilitated good $oordination bet/een publi$ debt anage ent and onetary poli$y for ulation. Cheres $o it ent to fis$al dis$ipline and redu$tion in oneti!ed defi$it have i parted $onsiderable autono y to the operation of onetary poli$y, the proa$tive debt anage ent by the RBI also fa$ilitated the $ondu$t of onetary poli$y, espe$ially through the use of indire$t instru ents. In fa$t, the substantial sto$k of Govern ent se$urities held by the RBI enabled it to sterili!e the onetary i pa$t of $apital flo/s through open arket operations sin$e the late 122)s. In re$ent years, /ith the reversal in the interest rate $y$le, the RBI /as able to pres$ribe higher risk /eights on assets to prote$t the balan$e sheet of the banks. 0his step $ertainly ensured finan$ial stability for the e$ono y. #e$ond, the RBI?s e5perien$e in anaging publi$ debt over the years has e=uipped it /ith the re=uisite te$hni$al $apa$ity of effi$iently fulfilling the t/in responsibilities of debt and onetary anage ent in tune /ith re=uire ents of the Govern ent and arket $onditions. 0he RBI has been aking efforts to develop the oney and govern ent se$urities arket sin$e 1244 and has gained valuable e5perien$e and kno/ledge about related arkets. 0his ay have been diffi$ult to a$$o plish if the debt anage ent fun$tion had been effe$tively separate. 0hird, in the ne5t five years, signifi$ant $hanges are slated to unfold in the Indian fis$al syste 6 operationalisation of the re$o endations of the 0/elfth ,inan$e Co ission, /hereby the Centre $eases to operate as an inter ediary for obili!ing resour$es for #tates /ith the latter having to raise funds dire$tly fro the arket7 the RBI?s /ithdra/al fro the pri ary arket of Govern ent paper fro 9pril 1, '))* has i pli$ations for the anage ent of interest rate e5pe$tations7 and i ple entation of the proposed a end ent to the Banking Regulation 9$t per itting fle5ibility to the RBI for lo/ering the #tatutory "i=uidity Ratio(#"R+ belo/ '. per $ent of net de and and ti e liabilities of banks /ould redu$e the $aptive subs$ription to Govern ent se$urities. Cith all of these $hanges taking pla$e in the onetary fis$al environ ent in the near future, there /ill be great need for a $ontinued high degree of $oordination in debt anage ent bet/een RBI and the Govern ent. In fa$t, in the ;.#., even though debt anage ent is for ally done by the 0reasury, the $lose $o-operation that a$tually e5ists bet/een the ,ederal Reserve Bank of %e/ Fork and the 0reasury is not very different in

fun$tion fro the relationship bet/een the RBI and the Govern ent in its debt anage ent fun$tion. 0he evaluation of our e5perien$e therefore supports the position that a prag ati$ vie/ needs to be taken on this issue keeping in ind the spe$ifi$ institutional $onte5t of a parti$ular $ountry in ind. Regulation and #upervision %or ally, there /ould be little dis$ussion of regulation and supervision of banks in the $onte5t of the relationship bet/een a $entral bank and the Govern ent. 0his issue arises in India be$ause of the predo inant Govern ent o/nership of banks after nationali!ation of banks in 12*2 and 124). By the 122)s, ore than 2) per $ent of banking assets /ere in banks o/ned by the Govern ent. In this institutional setting there /as a per$eption given that banks $annot fail and that depositors are effe$tively fully prote$ted. Moreover, all anage ent appoint ents in banks rested /ith the Govern ent, and hen$e the nor s of $orporate governan$e in publi$ se$tor banks. ,urther ore, in the presen$e of ad inistered deposit and lending rates, $redit allo$ation and other banking de$isions that rested /ith the govern ent, regulation and supervision of banks also effe$tively be$a e subservient to the Govern ent during the 12:)s and 124)s. An$e again, it /as only after the $hange in banking poli$y in 1221, e phasi!ing $o petition along /ith interest rate deregulation and eli ination of $redit allo$ation, that banking regulation and supervision by the Reserve Bank $ould be$o e effe$tive. It is the introdu$tion of $o petition through the entry of ne/ private se$tor banks and e5pansion of foreign banks, along /ith the idea of e=ual regulatory treat ent of private and publi$ se$tor banks, that has ne$essitated the pra$ti$e of odern regulation and supervision. 0he pro otion of safety and soundness of the banking syste and prote$tion of depositors have again be$o e relevant. 0he pri ary 8ustifi$ation for finan$ial regulation and supervision by regulatory authorities is to prevent syste i$ risk, avoid finan$ial $rises, prote$t depositors? interest and redu$e asy etry of infor ation bet/een depositors and finan$ial institutions. 0he business of banking has a nu ber of attributes that have the potential to generate instability as banks are u$h ore leveraged than other fir s due to their $apa$ity to garner publi$ deposits. 0herefore, the need for establishing an agen$y to regulate and supervise the banking a$tivity arose fro fre=uent bank failures in various $ountries /ith ra ifi$ations for the /hole e$ono y. 0he $entral banks had started to fo$us their attention on ensuring finan$ial stability and avoiding a finan$ial $risis, sin$e the late nineteenth $entury. 0he e5perien$e of the Great Depression had a profound effe$t on banking regulation in several $ountries and $o er$ial banks sin$e then have progressively been brought under the regulation of $entral banks. 0he basi$ ob8e$tive of bank supervision is to ensure that banks are finan$ially sound, /ell anaged and that they do not pose a threat to the interest of their depositors. 0he e phasis of supervision has been shifting in the re$ent period fro the traditional Capital, 9ssets, Manage ent, Earnings, "i=uidity and Interest Rate #ensitivity (C9ME"#+ approa$h to a ore risk-based approa$h. Basel II, /hi$h en$o passes the risk analysis, uses a >three-pillar? $on$ept I ini u $apital re=uire ents, supervisory revie/ and arket dis$ipline I to ensure finan$ial stability. Central banks have traditionally regulated and supervised finan$ial institutions, in$luding $o er$ial banks. Eo/ever, sin$e $entral banks are also regulators and influen$e the

behavior of arket parti$ipants, supervision $ondu$ted by $entral banks ay pose a oral ha!ard proble . 0herefore, the idea of a separate supervisory authority has gathered so e o entu in re$ent years. In addition, as a pra$ti$ing $entral banker, I $an envisage situations of $onfli$t bet/een onetary poli$y, and regulation and supervision, espe$ially in situations of e$ono i$ and finan$ial stress. 0o illustrate a $ase of $onfli$t, the ounting inflationary pressures in a $ountry ay re=uire interest rates to rise sharply but then banks /ould be potentially e5posed to /rite-do/ns of their asset valuations. 0he role of the RBI, in the $hanging environ ent, re$ognises the differen$es a ong various seg ents of the Indian banking syste and a$$o odates appropriate fle5ibility in the regulatory treat ent. 0he $hanging role of finan$ial regulation and supervision of the RBI $an be $hara$terised by less a$$ent on > i$ro? regulation but ore fo$us on >prudential? supervision, and on risk assess ent and $ontain ent. 0he Indian approa$h to banking se$tor refor s has been gradual and different fro any other e erging arket e$ono ies, /here finan$ial se$tor refor s resulted in privati!ation of erst/hile publi$ se$tor finan$ial inter ediaries. 9s the $o er$ial banks are s$heduled to start i ple enting Basel II /ith effe$t fro end-Mar$h ')):, the RBI /ill $ontinue to fo$us on supervisory $apa$ity-building easures to identify the gaps and to assess as /ell as =uantify the e5tent of additional $apital, /hi$h ay have to be aintained by su$h banks, due to operational and arket risk. ,inally, /hile re$ogni!ing the i portan$e of $onsolidation, $o petition and risk anage ent to the future of banking, the RBI /ill $ontinue to lay stress on $orporate governan$e, o/nership pattern of private banks, e5pansion of foreign banks and finan$ial in$lusion. %onetar# "olic# 0he operation of onetary poli$y in India before 1221 has to be analy!ed in the $onte5t of nationali!ation of banks, the then prevalent finan$ial repression and the $losed e$ono y. 0he banks /ere nationali!ed to e5er$ise so$ial $ontrol over their a$tivities. In ter s of out$o e, nationali!ation su$$eeded in spreading the net/ork of banks in rural areas and obili!ing private savings. 0he savings so obili!ed /ere used for supporting publi$ borro/ing as /ell as for eeting hitherto negle$ted genuine $redit needs in the rural areas. 0his $alled for signifi$ant $hanges in the institutional arrange ents, and ore stringent $ontrol and supervision of the banking syste . 0o a$$o odate the fis$al re=uire ents at lo/ rates of interest, interest rates /ere ad inistered and $redit /as dire$ted in spe$ifi$ so$ially preferred se$tors. 0he e$ono y /as $losed, e5$hange rates /ere fi5ed and e5$hange $ontrols /ere stri$tly observed. In this situation of nationali!ed banks, fis$al do inan$e and finan$ial repression, operation of the onetary poli$y /as severely $onstrained. Monetary poli$y resu ed its operational effi$ien$y /ith in$reasing liberali!ation of the e$ono y only after 1221. An$e again independen$e of onetary poli$y is ore related to $hange in the overall e$ono i$ poli$y fra e/ork and not fro a purist stan$e of separating the $entral bank fro the govern ent. 9s the finan$ial syste got liberali!ed up and onetary poli$y be$a e ore autono ous after the reversal of the previous e$hanis s, the $orresponding develop ent of the oney arket, Govern ent se$urities arket and the foreign e5$hange arket be$a e ne$essary. 9ppropriate onetary trans ission $annot take pla$e /ithout effi$ient pri$e dis$overy of interest rates and e5$hange rates in overall fun$tioning finan$ial arkets.

Earlier, various fa$tors su$h as ad inistered interest rates, dire$ted $redit progra es, /eak banking stru$ture, la$k of proper a$$ounting and risk anage ent syste s and la$k of transparen$y in operations of a8or finan$ial arket parti$ipants had hindered arket develop ent. 0he RBI, like other $entral banks, has taken a keen interest in the develop ent of finan$ial arkets, espe$ially the oney, govern ent se$urities and fore5 arkets in vie/ of their $riti$al role in the trans ission e$hanis of onetary poli$y. 0he oney arket is the fo$al point for intervention by the RBI to e=uilibrate short-ter li=uidity flo/s on a$$ount of its linkages /ith the foreign e5$hange arket. #i ilarly, the govern ent se$urities arket has be$o e i portant for the entire debt arket as it serves as a ben$h ark to pri$e other debt arket instru ents. 0he RBI had been aking efforts sin$e 124* to develop institutions and infrastru$ture for these arkets to fa$ilitate pri$e dis$overy. 0he $ons$ious efforts by the RBI to develop effi$ient, stable and healthy finan$ial arkets gained i portan$e after 1221. 0he RBI follo/ed a gradual and /ell-$alibrated poli$y to fa$ilitate the develop ent of arkets through institutional and finan$ial infrastru$ture develop ent through i prove ents in arket i$rostru$ture. 0he pa$e of the refor /as $ontingent upon putting in pla$e appropriate syste s and pro$edures, te$hnologies and arket pra$ti$es. 0here has been $lose $o-ordination bet/een the Central Govern ent and the RBI, as also bet/een different regulators, /hi$h helped in orderly and s ooth develop ent of the finan$ial arkets in India. ,ollo/ing the refor s, the arkets have no/ gro/n in si!e, depth and a$tivity paving the /ay for fle5ible use of indire$t instru ents by the RBI to pursue its ob8e$tives. In the $onte5t of the integration of Indian finan$ial arkets, /ith global arkets, the RBI has been $onstantly refining the operating pro$edures and instru ents as also various aspe$ts of finan$ial institutions, arkets and finan$ial infrastru$ture su$h as risk anage ent syste s, in$o e re$ognition and provisioning nor s, dis$losure nor s, a$$ounting standards and insolven$y in line /ith international best pra$ti$es (Mohan, '))*+. '. Autonom# of the eserve Bank of India 0he trend to/ards $entral bank independen$e is not of re$ent origin. In the pro$ess of evolution, globally, /hile the spe$tru of a$tivities of the $entral banks has /idened, the stan$e regarding the independen$e of $entral banks has taken an interesting turn. Before the ,irst Corld Car, the $entral banks in ost $ases /ere private institutions and /ere for ally independent of their govern ents. Interestingly, so e $entral banks /ere established to serve as banker and debt anager to the govern ent. 0he position $hanged around the #e$ond Corld Car - $entral banks in a nu ber of $ountries (e.g., Ger any, ,ran$e, England, &apan, Italy and #/eden+ /ere ade subordinate to their govern ents. In re$ent years again, there has been a reversal in the trend. Govern ents have started granting ore autono y to their $entral banks6 on the argu ent that a $ountry is ore likely to have lo/ inflation if the $entral bank is independent. 0his argu ent has its roots in the breakdo/n of gold standard in early 12:)s and the phase of high inflation that follo/ed during the 12:)s and 124)s. 0o a$hieve pri$e stability, in$reasingly, $entral banks /ere granted autono y along /ith an inflation target to eet, i plying that independen$e /as saddled /ith a$$ountability. 0o illustrate, the Bank of England, /hi$h had substantial independen$e for u$h of the eighteenth and nineteenth $entury, but /as later ade subservient to the govern ent, /as legally granted independen$e in &une 1224 but /ith an inflation target to a$hieve. 0he re$ent trend to/ards $entral bank

independen$e has been influen$ed greatly by the e5perien$e of the Bundes Bank and Reserve Bank of %e/ Jealand. In the Indian $onte5t, $entral bank autono y has to be e5a ined in a different $onte5t. Initially, sin$e the laun$h of the ,ive-year Dlans, onetary poli$y /as e5pe$ted to a$$o odate the e5pansionary fis$al poli$y, as I have dis$ussed, to eet the re=uire ents of the Govern ent. "ater, to eet so$ial obligations, the $o er$ial banks /ere nationali!ed and statutory ratios raised, interest rates /ere ad inistered, $redit /as rationed and $hanneled into priority se$tor, e5$hange rate /as fi5edH anaged, the e$ono y /as $losed and ove ent of foreign e5$hange /as stri$tly $ontrolled. In su$h an arrange ent, there /as no s$ope for autono y of onetary poli$y. #in$e 1221, due to refor s, the situation has $hanged. 0he refor s have led to disinvest ent in publi$ se$tor banks, en$ourage ent given to private se$tor banks, deregulation of interest rates, lo/ering of statutory ratios, $essation of auto ati$ oneti!ation and i ple entation of $urrent a$$ount $onvertibility. In re$ent years, short-ter li=uidity in the arket is being anaged su$$essfully by the operation of a li=uidity ad8ust ent fa$ility on a daily basis, /hile longer ter li=uidity has been addressed through traditional AMAs (Apen Market Aperations+ in govern ent se$urity au$tions. 9s e5$ess foreign e5$hange inflo/s intensified in '))3-'))(, $ooperation bet/een the Reserve Bank and the Central Govern ent resulted in a rare innovation designed to e po/er the RBI /ith ne/ instru ents for sterlisation. 0he govern ent agreed to per it the RBI to issue additional govern ent se$urities for sterlisation purposes upto a spe$ified li it. 0hus Govern entHRBI $ooperation resulted in a ne/ instru ent that strengthened the Reserve Bank in pursuing its onetary poli$y ob8e$tives. Monetary poli$y operation has also been $onstrained by the e5isten$e of ini u li its, on the CRR (Cash Reserve Ratio+ of 3 per $ent, and on the #"R of '. per $ent. In order to provide greater onetary poli$y fle5ibility to the RBI the Govern ent has agreed to eli inate these ini u li its through introdu$tion of a end ents to the relevant a$ts in Darlia ent. 0hus, onetary poli$y has oved fro using dire$t instru ents to arket based indire$t instru ents, /ith the develop ent of the oney and govern ent se$urities arket. 0hese develop ents sin$e 1221 indi$ate that the RBI already en8oys substantial autono y in for ulation of onetary poli$y. Inflation 0argeting Central banks are divided on the advisability of setting e5pli$it inflation targets. #everal $entral banks, su$h as, Bank of Canada, Bank of England, and the Reserve Bank of %e/ Jealand, have adopted e5pli$it inflation targets. Athers, /hose $redibility in fighting inflation is long established (e.g., the Bundesbank (earlier+ and the #/iss %ational Bank+, do not set e5pli$it annual inflation targets. Eo/ever, $on$entrating only on nu eri$al inflation ob8e$tives ay redu$e the fle5ibility of onetary poli$y, espe$ially /ith respe$t to other poli$y goals. Eigh and sustained gro/th of the e$ono y in $on8un$tion /ith lo/ inflation is the $entral $on$ern of onetary poli$y in India. 0he rate of inflation $hosen as the poli$y ob8e$tive has to be $onsistent /ith the desired rate of output and e ploy ent gro/th. 9n inappropriate $hoi$e $an lead to losses of a$roe$ono i$ /elfare. Monetary authorities have to $ontinually $ontend /ith the short-run trade-off bet/een gro/th and inflation. 0he proble is $o pounded by the fa$t that the asso$iation bet/een gro/th and inflation is non-linear. 9t so e lo/ rates, inflation $ould operate in a anner that assists in

bringing ba$k une ployed resour$es into the e$ono y and be benefi$ial or, at /orst, neutral to gro/th. 9t higher levels, inflation is ini i$al to gro/th. 0here are also very lo/ levels of inflation that are asso$iated /ith no gro/th or even deflation. 9t /hat level should the poli$y $hoi$e of inflation be or /hat is the threshold rate of inflation, if there is one, /hi$h is asso$iated /ith the absen$e of har ful effe$ts of gro/th@ 0here have been various studies that have atte pted to esti ate threshold inflation rates. 0hey suggest that the threshold inflation rate depends upon a nu ber of fa$tors su$h as the stru$ture of the e$ono y, past inflation history, the degree of inde5ation, and inflation e5pe$tations. #o e studies suggest that the threshold inflation for developed and developing $ountries fall in the ranges of 1-3 per $ent and :-11 per $ent, respe$tively. 9n abiding proble /ith $ross-$ountry studies, ho/ever, is the risk of being influen$ed by e5tre e values sin$e sa ples in$lude $ountries /ith inflation as lo/ as one per $ent and as high as ')) per $ent and even higher. 0he esti ation of su$h inflation threshold rates, therefore, needs to be done for ea$h $ountry separately, in order to understand the behaviour of the e$ono y in relation to inflation. 9 a8or sour$e of un$ertainty in $ondu$ting onetary poli$y is the la$k of a $lear understanding of the inflationary pro$ess as it has unfolded in re$ent years. 0his has obs$ured a proper assess ent of the nature of sho$ks i pa$ting on the e$ono y and the resulting risks to pri$e stability. <ariations in the ti eliness and reliability of inflation indi$ators, un$ertainty surrounding unobservable indi$ators like potential output and gaps in the intrinsi$ kno/ledge of the $entral banks about the state of the e$ono y $o pli$ate the aking of onetary poli$y. In $ountries like ours, there are other rigidities related to ad inistered pri$es, /age setting pro$edures, and /eather indu$ed supply sho$ks that influen$e pri$es. Bno/ledge of the relationship bet/een inflation and its deter inants re ains li ited. Even if there /ere a $onsensus on a suitable odel, $onsiderable un$ertainty /ould re ain regarding the strength of the stru$tural relationships /ithin the odel. 9n even ore funda ental proble is that para eters ay vary over ti e as a result of stru$tural $hanges in the e$ono y. 0his presu ably e5plains /hy no $entral bank uses a for al odel to derive its a$tual poli$ies7 for the foreseeable future, odels /ill be an aid to 8udg ent rather than a substitute for 8udg ent. 0he si ple prin$iple of inflation targeting thus is also not so si ple and, poses proble s for onetary poli$y aking in developing $ountries. In India, /e have not favoured the adoption of inflation targeting, /hile keeping the attain ent of lo/ inflation as a $entral ob8e$tive of onetary poli$y, along /ith that of high and sustained gro/th that is so i portant for a developing e$ono y. 9part fro the legiti ate $on$ern regarding gro/th as a key ob8e$tive, there are other fa$tors that suggest that inflation targeting ay not be appropriate for India. ,irst, unlike any other developing $ountries /e have had a re$ord of oderate inflation, /ith double digit inflation being the e5$eption, and largely so$ially una$$eptable. #e$ond, adoption of inflation targeting re=uires the e5isten$e of an effi$ient onetary trans ission e$hanis through the operation of effi$ient finan$ial arkets and absen$e of interest rate distortions. In India, although the oney arket, govern ent debt and fore5 arket have indeed developed in re$ent years, they still have so e /ay to go, /hereas the $orporate debt arket is still to develop. 0hough interest rate deregulation has largely been a$$o plished, so e ad inistered interest rates still persist. 0hird, inflationary pressures still often e anate fro signifi$ant supply sho$ks related to the effe$t of the

onsoon on agri$ulture, /here onetary poli$y a$tion ay have little role. ,inally, in an e$ono y as large as that of India, /ith various regional differen$es, and $ontinued e5isten$e of arket i perfe$tions in fa$tor and produ$t arkets bet/een regions, the $hoi$e of a universally a$$eptable easure of inflation is also diffi$ult. <I. 0he Cay 9head 0he RBI has, over the years transfor ed itself $ontinuously fun$tionally and stru$turally in response to the $hanging needs of the e$ono y and Govern ent poli$ies. #in$e 1221, a spe$ial period of refor s and $hange has been ushered in the e$ono y and the RBI has parti$ipated in this $hange very a$tively. 0he RBI $ontinues to pursue the develop ent role but no/ /ith so e differen$e. In re$ent years, it has ade $onsistent efforts to develop finan$ial arkets, build institutions and en$ourage use of te$hnology in the finan$ial syste . 0he e$ono y is passing through a ne/ phase due to the ena$t ent of the ,is$al Responsibility and Budget Manage ent Bill, en$ouraging parti$ipation of private and foreign banks, in$reasing globalisation and $ontinued liberalisation of the $apital a$$ount. 0he gross savings rate is nearly 3) per $ent of GDD and the e$ono y is re$ording a gro/th rate of about 4 per $ent annually, in re$ent years. In this situation, a substantial in$rease in household finan$ial savings is e5pe$ted as /ell as the need for higher $redit disburse ent in the e$ono y. 0he e phasis on finan$ial in$lusion /ill also lead to enhan$ed need for finan$ial inter ediation. 0he finan$ial institutions /ould therefore have to prepare for higher volu e of transa$tions. In vie/ of the e5pe$ted in$rease in $o petition, banking institutions /ould need to integrate various servi$es like banking, e-$o er$e, utual funds, insuran$e, and oney arket operations. 0he ne/ $hallenges fa$ing the RBI are any. ,irst, if the Indian banking syste is to attain international e5$ellen$e, it /ill re=uire a$tion on several fronts like introdu$tion of greater $o petition7 $onvergen$e of a$tivities and supervision of finan$ial $onglo erates7 indu$tion of ne/ te$hnology7 i prove ent in $redit risk appraisal7 en$ourage ent of finan$ial innovation7 i prove ent in internal $ontrols and establish ent of an appropriate legal fra e/ork. 0he role of the RBI in this $onte5t a ounts to pro oting safety and soundness /hile allo/ing the banking syste to $o pete and innovate. #e$ond, as a $entral bank, the RBI /ould further need to develop the finan$ial arkets, espe$ially the oney, govern ent se$urities and foreign e5$hange arkets to enhan$e the effi$ien$y of the trans ission e$hanis , along /ith the $orporate debt arket. 0hird, pri$e stability and finan$ial stability /ould $ontinue to be of $on$ern /ith e5pe$ted in$rease in $redit e5pansion and global integration. ,ourth, $on$erns regarding so$ial se$urity, and invest ent of pension and insuran$e funds /ould need to be addressed. I /ould like to finish on an opti isti$ note. 9s the RBI has su$$essfully fa$ed $hallenges in the past, it $an be e5pe$ted to $ontinue to adapt to the $hanging e$ono i$ environ ent in future. Ce need to be indful of the e5tant ob8e$tives of overall e$ono i$ poli$y, /ithin /hi$h onetary poli$y has to be pla$ed, and the realities of e$ono i$ anage ent in India, as /e $onte plate the further evolution of $entral banking and finan$ial regulation in India Referen$es Bing, Mervyn ('))(+6 K0he Institutions of Monetary Doli$y,K 9 eri$an E$ono i$ Revie/, <ol. 2((May+, pp. 1-13.

Mohan, Rakesh ('))*+6 KCoping Cith "i=uidity Manage ent in India6 9 Dra$titionerKs <ie/K, RBI Bulletin, 9pril. Reserve Bank of India (')).a+6 Report on Curren$y and ,inan$e6 '))(-)., Mu bai6 Reserve Bank of India. Reserve Bank of India (')).b+6 (Eistory of+ Reserve Bank of India (3 volu es+, Mu bai6 Reserve Bank of India.