Aspirant Academy

Economy

Predicted Questions with Model Answers

RBI, Monetary Management, Banking & Financial Reforms

Paper I · Unit 2 Section 9 of 11 0 PYQs 29 min
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Predicted Questions with Model Answers

Q1 (5 marks — 50 words): What is the Monetary Policy Committee (MPC)? State its composition and inflation target.

Model Answer:

The Monetary Policy Committee (MPC) was constituted under the RBI Act 1934 (amended 2016) to set the repo rate by majority vote. Composition: 6 members — 3 from RBI (Governor as Chair, Deputy Governor, Executive Director) + 3 external members appointed by government for 4-year terms. Meets 6 times/year. Mandate: maintain CPI inflation at 4% ± 2% (2–6% tolerance band). If CPI exceeds 6% for 3 consecutive quarters, RBI must report to government.

Q2 (5 marks — 50 words): Distinguish between CRR and SLR. What is their current level?

Model Answer:

CRR (Cash Reserve Ratio): Proportion of bank deposits banks must keep as cash with RBI — currently 4%. Banks earn no interest on CRR balances. Its primary purpose is liquidity control and reserve management. SLR (Statutory Liquidity Ratio): Proportion of deposits banks must hold in liquid assets (government securities, cash, approved gold) — currently 18%. Banks can earn interest on SLR assets. A CRR/SLR hike reduces money supply (contractionary); a cut expands it.

Q3 (5 marks — 50 words): What is IBC 2016? State its key features.

Model Answer:

The Insolvency and Bankruptcy Code (IBC) 2016 is India's landmark financial reform that provides a time-bound corporate insolvency resolution process. Key features: (1) 180-day resolution window (extendable to 270 days) — strict timeline eliminates delay; (2) Creditor-controlled process — Committee of Creditors (CoC) approves resolution plans; (3) NCLT is the adjudicating authority; (4) Replaced 12 overlapping insolvency laws; (5) Recovery achievement: Rs 3.3 lakh crore realised by creditors (2016–2024).

Q4 (5 marks — 50 words): What is the Digital Rupee? How does it differ from UPI?

Model Answer:

The Digital Rupee (e-Rs) is India's Central Bank Digital Currency (CBDC) — a sovereign digital currency issued by RBI directly (RBI's liability). Piloted from November 2022 (wholesale) and December 2022 (retail). Unlike UPI — which transfers money between bank accounts and is a payment system, not money itself — the Digital Rupee is money in electronic form, like a digital banknote. It works offline, is programmable, and carries no interest. The distinction: UPI is a rail (infrastructure); Digital Rupee is money itself.

Q5 (10 marks — 150 words): Discuss India's banking sector reforms since 1991. What challenges remain?

Model Answer:

India's banking reforms since 1991 constitute one of the most comprehensive financial sector transformations in any developing economy.

Phase I — Narasimham Committee Reforms (1991-1998):
The M. Narasimham Committee (1991) laid the foundation — deregulating interest rates from administered to market-determined, reducing CRR from 15% and SLR from 38.5% to current 4%/18% respectively. It introduced IRAC norms defining NPAs, established Debt Recovery Tribunals (DRTs), and recommended new private bank licences — leading to HDFC Bank, ICICI Bank, and UTI Bank (Axis) in 1994. The 1998 Narasimham Committee II recommended capital adequacy norms (Basel framework), bank consolidation, and conversion of DFIs.

Phase II — Post-2004 Reforms:

  • Basel II and III capital adequacy implementation (CRAR minimum 9% vs. global 8%)
  • Core Banking Solutions (CBS) modernization — all PSBs on CBS by 2010
  • Financial Inclusion drive — Basic Savings Bank Deposit Accounts (BSBDA)
  • Priority Sector Lending (PSL) norms refined; MSME, affordable housing added

Phase III — Post-2014 Structural Reforms:

  • IBC 2016: Time-bound insolvency — recovered Rs 3.3 lakh crore (2016-24); NPA reduced from 11.5% peak to 2.67% (Sep 2024)
  • PSB Mergers: 27 PSBs → 12 via mega-mergers; larger banks with global scale
  • Differentiated Banking: Small Finance Banks (12) and Payments Banks (6) — serving excluded segments
  • Digital Payments: UPI, IMPS, RuPay, FASTag — India processes 50%+ global real-time payments
  • MPC Framework (2016): Inflation targeting — transparent, rule-based monetary policy
  • PSB Recapitalisation: Rs 3.12 lakh crore infused (2015-21)

Remaining Challenges:

  1. Government ownership dominance: PSBs still hold 60%+ of banking assets — governance and political interference persist
  2. Credit Penetration: Credit-to-GDP ratio at ~57% — below China's 175% or even global average of 100%
  3. NBFC Fragility: IL&FS (2018) and subsequent NBFC stress revealed systemic risks from shadow banking
  4. Cybersecurity: Rising fraud — digital banking fraud crossed Rs 13,900 crore in FY2023-24
  5. Agricultural Credit Stress: Loan waivers and farm credit NPAs remain structural issues

Q6 (10 marks — 150 words): Explain the role of RBI as a regulator and supervisor of India's banking system.

Model Answer:

The Reserve Bank of India (RBI), established in 1935 and nationalised in 1949, is India's apex monetary and banking authority. Its regulatory and supervisory role is multidimensional.

Regulatory Powers (Banking Regulation Act 1949):
RBI regulates entry, exit, capital adequacy, and business conduct of all banking entities:

  1. Licensing: Grant and cancellation of banking licences — no bank can operate without RBI licence
  2. Capital Adequacy: Mandates CRAR (Capital to Risk-weighted Assets Ratio) of minimum 9% (above Basel III's 8%); additional buffers — Capital Conservation Buffer (2.5%), Countercyclical Capital Buffer
  3. Exposure Norms: Large Exposure Framework — no single borrower/group can receive >25% of Tier 1 capital; prevents concentration risk
  4. Fit and Proper Criteria: Directors and key management of banks must meet integrity and competence standards; RBI can remove directors
  5. Interest Rate Guidance: While deposit/lending rates are market-determined, RBI mandates EBLR (repo-linked) for retail and MSME loans

Supervisory Mechanisms:

  1. Annual Financial Inspection (AFI): On-site inspection of every scheduled bank annually by RBI's Department of Supervision; evaluates asset quality, capital, liquidity, management, earnings
  2. Off-Site Monitoring and Surveillance (OSMOS): Continuous monitoring of financial returns submitted by banks; early warning system for stress
  3. Prompt Corrective Action (PCA): Invoked for banks breaching thresholds on NPA ratio, capital adequacy, or return on assets — restricts dividend, lending, branch expansion, management remuneration until bank recovers
  4. Resolution of Weak Banks: RBI can apply to NCLT for liquidation, arrange voluntary mergers (Bank of Rajasthan → ICICI), orchestrate bail-in/bail-out (YES Bank 2020 — SBI-led rescue)

Recent Regulatory Initiatives:

  • Scale-Based Regulation (SBR) for NBFCs (2021): 4-layer classification — Base/Middle/Upper/Top — with differentiated regulation based on size and systemic importance
  • Revised KYC Norms (2021): Digital KYC via video-based customer identification; Aadhaar-OTP based eKYC
  • Cybersecurity Framework: RBI's IT Examination Framework mandates cybersecurity audits, breach reporting