Financial crisis 2008: Response of RBI and Indian banks

Abstract

The world has witnessed one of the worst economic and financial crises in the year 2008-09 since the great depression of 1929. India too along with the whole world was impacted by the crisis in terms of severe credit crunch, net negative inflows, slowdown in exports, job losses, etc. During the time of the crisis, several stakeholders like the central bank (RBI), the market regulator (SEBI), and the government played their part well to reduce the impact of the crisis on India. The Reserve Bank of India (RBI) handled the crisis through its monetary policies, the Securities and Exchange Board of India (SEBI) through its control over stock exchanges, Government through its fiscal policies. RBI through its monetary policies has changed the following variables as follows during 2007 to 2009: i) Bank Rate was left unchanged ii) Reverse Repo Rate was changed 4 times iii) Repo Rate was changed 11 times iv) Cash Reserve Ratio was changed 17 times and v) Statutory Liquidity Ratio was changed once. RBI raised the Repo Rate and Cash Reserve Ratio during 2007 till late 2008 to contain inflation. RBI decreased Reserve Repo Rate, Repo Rate, Cash Reserve Ratio and Statutory Liquidity Ratio during late 2008 till 2009 to tackle the spillover effects of financial shock from the global markets. RBI wanted to maintain comfortable rupee liquidity, to augment forex liquidity and to arrest growth in moderation. If noticed, we see that Reverse Repo Rate and Repo Rate were changed very few times compared to Cash Reserve Ratio though all of them signify either absorption or injection of liquidity. That’s because changing Cash Reserve Ratio has immediate and fastest effect on either absorption or injection of liquidity into the economy compared to Reverse Repo Rate or Repo Rate thereby changing the course of action in the direction RBI wants. Finally, changing Cash Reserve Ratio frequently helped in controlling the inflation as well as increasing the demand in the domestic market. Government stimulated the economy during the crisis through borrowings and large investments. The central government launched two fiscal packages in December 2008 and January 2009. These fiscal stimulus packages amounting to about 3% of GDP included public spending, capital expenditure, infrastructure spending, cut in indirect taxes, additional support to exporters, etc. The large domestic demand bolstered by the government consumption, provision for forex and rupee liquidity coupled with sharp cuts in policy rates, a sound banking sector and a wellfunctioning financial markets helped mitigate the impact of the crisis on India. Financial crisis taught that us that greed is not always good. Banks also learnt a lesson on to take calculated risks and not play with other’s money. Financial leverage is not always the good option. The crisis also raised a need to reexamine the authenticity of the credit agencies and their fee structure.