Monetary Management and The Financial Intermediation: Stability is The Watchword | Indian Economy for UPSC CSE PDF Download

 Page 1


CHAPTER
02
MONETARY MANAGEMENT 
AND FINANCIAL 
INTERMEDIATION: 
STABILITY IS THE 
WATCHWORD
India’s banking and financial sectors have displayed a stellar performance in FY24. 
Double-digit and broad-based growth in bank credit, gross and net non-performing 
assets at multi-year lows, and improvement in bank asset quality highlight the 
government’s commitment to a healthy and stable banking sector. Capital markets 
are becoming prominent in India’s growth story, with an expanding share in capital 
formation and investment landscape on the back of technology, innovation, and 
digitisation. Indian stock market was among the best-performing markets, with India’s 
Nifty 50 index ascending by 26.8 per cent during FY24, as against (-)8.2 per cent during 
FY23. The market capitalisation of the Indian stock market has seen a remarkable 
surge, with the market capitalisation to GDP ratio being the fifth largest in the World. 
Supported by regulatory measures and the vision to achieve ‘Insurance for all by 2047’, 
India is poised to emerge as one of the fastest-growing insurance markets over the next 
five years. The pension sector witnessed a robust increase in subscribers and assets 
under management. 
While the outlook for India’s financial sector appears bright, some areas will require 
focused attention going forward. The significant increase in retail investors in the 
stock market calls for careful consideration. This is crucial because the possibility of 
overconfidence leading to speculation and the expectation of even greater returns, which 
might not align with the real market conditions, is a serious concern. For a developing 
economy such as India, the financial sector needs to support the banking sector and fill 
the gap in capital required for the economy's growth. Therefore, the financial sector 
should expand at a pace that is in lockstep with economic growth. In particular, India 
can ill-afford the economy's over financialisation at its current development stage. 
The increased retail participation in financial markets and familiarity with financial 
products are beginning to grow in line with India’s emergence as the world’s fifth-largest 
economy. Therefore, firms operating in banking, insurance, and capital markets must 
keep the interests of the consumers in mind and improve their service quality through 
fair selling, disclosure, transparency, reliability, and responsiveness. Their internal 
appraisal and incentive systems must be in alignment with these considerations. It is in 
their interest and in the interest of the nation that they optimise their commercial goals 
over the long run. 
Page 2


CHAPTER
02
MONETARY MANAGEMENT 
AND FINANCIAL 
INTERMEDIATION: 
STABILITY IS THE 
WATCHWORD
India’s banking and financial sectors have displayed a stellar performance in FY24. 
Double-digit and broad-based growth in bank credit, gross and net non-performing 
assets at multi-year lows, and improvement in bank asset quality highlight the 
government’s commitment to a healthy and stable banking sector. Capital markets 
are becoming prominent in India’s growth story, with an expanding share in capital 
formation and investment landscape on the back of technology, innovation, and 
digitisation. Indian stock market was among the best-performing markets, with India’s 
Nifty 50 index ascending by 26.8 per cent during FY24, as against (-)8.2 per cent during 
FY23. The market capitalisation of the Indian stock market has seen a remarkable 
surge, with the market capitalisation to GDP ratio being the fifth largest in the World. 
Supported by regulatory measures and the vision to achieve ‘Insurance for all by 2047’, 
India is poised to emerge as one of the fastest-growing insurance markets over the next 
five years. The pension sector witnessed a robust increase in subscribers and assets 
under management. 
While the outlook for India’s financial sector appears bright, some areas will require 
focused attention going forward. The significant increase in retail investors in the 
stock market calls for careful consideration. This is crucial because the possibility of 
overconfidence leading to speculation and the expectation of even greater returns, which 
might not align with the real market conditions, is a serious concern. For a developing 
economy such as India, the financial sector needs to support the banking sector and fill 
the gap in capital required for the economy's growth. Therefore, the financial sector 
should expand at a pace that is in lockstep with economic growth. In particular, India 
can ill-afford the economy's over financialisation at its current development stage. 
The increased retail participation in financial markets and familiarity with financial 
products are beginning to grow in line with India’s emergence as the world’s fifth-largest 
economy. Therefore, firms operating in banking, insurance, and capital markets must 
keep the interests of the consumers in mind and improve their service quality through 
fair selling, disclosure, transparency, reliability, and responsiveness. Their internal 
appraisal and incentive systems must be in alignment with these considerations. It is in 
their interest and in the interest of the nation that they optimise their commercial goals 
over the long run. 
Economic Survey 2023-24
38
INTRODUCTION
2.1 The Indian economy's financial and banking sectors have shown strong performance 
despite continuous geopolitical challenges. The Central Bank maintained a steady policy rate 
throughout the year, with the overall inflation rate under control. The effects of the monetary 
tightening following the Russia-Ukraine conflict are evident in the lending and deposit interest 
rates increase among banks. Bank loans saw significant and widespread growth across various 
sectors, with personal loans and services leading the way. 
2.2 Capital markets have also shown impressive results, with India's stock market 
capitalisation to GDP ratio ranking fifth globally.
1
 The presence of a robust Digital Public 
Infrastructure (DPI) and the greater involvement of banks and microfinance institutions 
(MFIs) have contributed to improved financial inclusion. The insurance and pension sectors 
are also doing well, as indicated by their expanding coverage.
2.3 Against this backdrop, the chapter is divided into two parts-Monetary developments and 
financial intermediation. The monetary developments part presents the monetary and liquidity 
conditions of the economy. 
2.4 The financial intermediation part offers a discussion on the state of various financial 
institutions and financial market instruments that form part of the financial market milieu in 
India. Section I of this part presents the performance of the country's banking sector, which 
is the most critical pillar of the financial intermediation landscape. Section II highlights the 
Government’s mechanism for dealing with distressed assets and how the Insolvency and 
Bankruptcy Code, 2016 (IBC/Code) has emerged as a game-changer in resolving insolvencies. 
Section III discusses the Government’s approach towards financial inclusion with increased 
emphasis on digital financial inclusion and data protection. Section IV highlights the role of 
MFIs in facilitating financial inclusion and promoting inclusive growth. Section V discusses the 
securities markets, which have come a long way to become an alternative and efficient means 
of resource mobilisation for the corporate sector and the Government. The global stature of 
India’s securities markets in using technology and best practices in regulations is a matter of 
pride. Section VI concerns the International Financial Services Centre, Gujarat International 
Finance Tec-City (IFSC GIFT City) and how it is emerging as a global financial and IT service 
hub. Sections VII and VIII present the developments in the insurance and pension sectors. 
Section IX discusses the government’s mechanism to ensure regulatory coordination and 
overall financial stability, highlighting the role of the Financial Stability and Development 
Council (FSDC). Section X provides an overall conclusion and the outlook for the financial 
sector while mentioning the key challenges to tackle going forward.
1   As per the World Federation of Exchanges (WFE)
Page 3


CHAPTER
02
MONETARY MANAGEMENT 
AND FINANCIAL 
INTERMEDIATION: 
STABILITY IS THE 
WATCHWORD
India’s banking and financial sectors have displayed a stellar performance in FY24. 
Double-digit and broad-based growth in bank credit, gross and net non-performing 
assets at multi-year lows, and improvement in bank asset quality highlight the 
government’s commitment to a healthy and stable banking sector. Capital markets 
are becoming prominent in India’s growth story, with an expanding share in capital 
formation and investment landscape on the back of technology, innovation, and 
digitisation. Indian stock market was among the best-performing markets, with India’s 
Nifty 50 index ascending by 26.8 per cent during FY24, as against (-)8.2 per cent during 
FY23. The market capitalisation of the Indian stock market has seen a remarkable 
surge, with the market capitalisation to GDP ratio being the fifth largest in the World. 
Supported by regulatory measures and the vision to achieve ‘Insurance for all by 2047’, 
India is poised to emerge as one of the fastest-growing insurance markets over the next 
five years. The pension sector witnessed a robust increase in subscribers and assets 
under management. 
While the outlook for India’s financial sector appears bright, some areas will require 
focused attention going forward. The significant increase in retail investors in the 
stock market calls for careful consideration. This is crucial because the possibility of 
overconfidence leading to speculation and the expectation of even greater returns, which 
might not align with the real market conditions, is a serious concern. For a developing 
economy such as India, the financial sector needs to support the banking sector and fill 
the gap in capital required for the economy's growth. Therefore, the financial sector 
should expand at a pace that is in lockstep with economic growth. In particular, India 
can ill-afford the economy's over financialisation at its current development stage. 
The increased retail participation in financial markets and familiarity with financial 
products are beginning to grow in line with India’s emergence as the world’s fifth-largest 
economy. Therefore, firms operating in banking, insurance, and capital markets must 
keep the interests of the consumers in mind and improve their service quality through 
fair selling, disclosure, transparency, reliability, and responsiveness. Their internal 
appraisal and incentive systems must be in alignment with these considerations. It is in 
their interest and in the interest of the nation that they optimise their commercial goals 
over the long run. 
Economic Survey 2023-24
38
INTRODUCTION
2.1 The Indian economy's financial and banking sectors have shown strong performance 
despite continuous geopolitical challenges. The Central Bank maintained a steady policy rate 
throughout the year, with the overall inflation rate under control. The effects of the monetary 
tightening following the Russia-Ukraine conflict are evident in the lending and deposit interest 
rates increase among banks. Bank loans saw significant and widespread growth across various 
sectors, with personal loans and services leading the way. 
2.2 Capital markets have also shown impressive results, with India's stock market 
capitalisation to GDP ratio ranking fifth globally.
1
 The presence of a robust Digital Public 
Infrastructure (DPI) and the greater involvement of banks and microfinance institutions 
(MFIs) have contributed to improved financial inclusion. The insurance and pension sectors 
are also doing well, as indicated by their expanding coverage.
2.3 Against this backdrop, the chapter is divided into two parts-Monetary developments and 
financial intermediation. The monetary developments part presents the monetary and liquidity 
conditions of the economy. 
2.4 The financial intermediation part offers a discussion on the state of various financial 
institutions and financial market instruments that form part of the financial market milieu in 
India. Section I of this part presents the performance of the country's banking sector, which 
is the most critical pillar of the financial intermediation landscape. Section II highlights the 
Government’s mechanism for dealing with distressed assets and how the Insolvency and 
Bankruptcy Code, 2016 (IBC/Code) has emerged as a game-changer in resolving insolvencies. 
Section III discusses the Government’s approach towards financial inclusion with increased 
emphasis on digital financial inclusion and data protection. Section IV highlights the role of 
MFIs in facilitating financial inclusion and promoting inclusive growth. Section V discusses the 
securities markets, which have come a long way to become an alternative and efficient means 
of resource mobilisation for the corporate sector and the Government. The global stature of 
India’s securities markets in using technology and best practices in regulations is a matter of 
pride. Section VI concerns the International Financial Services Centre, Gujarat International 
Finance Tec-City (IFSC GIFT City) and how it is emerging as a global financial and IT service 
hub. Sections VII and VIII present the developments in the insurance and pension sectors. 
Section IX discusses the government’s mechanism to ensure regulatory coordination and 
overall financial stability, highlighting the role of the Financial Stability and Development 
Council (FSDC). Section X provides an overall conclusion and the outlook for the financial 
sector while mentioning the key challenges to tackle going forward.
1   As per the World Federation of Exchanges (WFE)
Monetary Management and Financial Intermediation
39
MONETARY DEVELOPMENTS
2.5 Monetary policy plays a crucial role in determining the economic conditions of a country 
through its influence on macroeconomic indicators such as economic growth, inflation, and 
investments. The primary objective of monetary policy is to maintain price stability while 
keeping in mind the objective of growth. Various instruments of monetary policy, viz. cash 
reserve ratio (CRR) and statutory liquidity ratio (SLR) of banks, open market operations of 
the Central Bank, and imposition of credit ceilings, etc., are used by the central bank in the 
direction of this overall objective. This section of the chapter presents the recent monetary 
developments in the economy, focussing on the emerging liquidity conditions and monetary 
policy transmission in terms of lending and deposit rates of banks.
Monetary and Credit Conditions
2.6 Monetary and credit conditions evolved in line with the monetary policy stance during 
the year, supporting domestic economic activity. The Monetary Policy Committee (MPC) 
maintained the status quo on the policy repo rate at 6.5 per cent in FY24. It focused on 
withdrawing accommodation to ensure that inflation gradually aligns with the target while 
supporting growth. With the cumulative policy repo rate hike of 250 basis points (bps), 
undertaken between May 2022 and February 2023, working its way through the economy, 
the MPC kept the policy repo rate unchanged at 6.5 per cent since February 2023, but with 
readiness to undertake appropriate and timely policy actions if the situation so warrants. 
2.7 Important factors impacting the evolution of monetary and credit conditions during 
FY24 were the withdrawal of ?2,000 banknotes (May 2023)
2
, the merger of HDFC, a non-bank 
with HDFC Bank (July 2023), and the temporary imposition of the incremental CRR (I-CRR) 
(August 2023). The expansion in reserve money and currency in circulation (CiC) moderated 
due to the return of a predominant part of ?2,000 banknotes to the banking system as deposits. 
As per the Reserve Bank of India (RBI), the total value of ?2,000 banknotes in circulation has 
declined from ?3.56 lakh crore as of 19 May 2023 (when the withdrawal of ?2,000 banknotes 
was announced) to ?7,581 crore as of 28 June 2024, indicating that 97.87 per cent of the ?2,000 
denomination banknotes have returned to the banking system.
3
 This and an increase in term 
deposit rates contributed to an acceleration in aggregate deposits and broad money (M3). The 
growth in CiC moderated to 4.1 per cent from 7.8 per cent YoY in the last year, reflecting the 
impact of the withdrawal of ?2,000 banknotes.
2.8 Reserve Money (M0) recorded a year-on-year (YoY) growth of 6.7 per cent as of 29 March 
2024, compared to 9.7 per cent in the previous year. M0, adjusted for the first-round impact of 
2   Vide circular dated 19 May 2023 https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=55707, RBI announced 
the withdrawal of ?2000 banknotes from circulation since (i) about 89% of the ?2000 denomination banknotes were issued 
before March 2017 and are at the end of their estimated life-span of 4-5 years; (ii) the total value of these banknotes in circulation 
has declined from ?6.7 lakh crore at its peak as of 31 March 2018 (37.3% of Notes in Circulation) to ?3.62 lakh crore, constituting 
only 10.8% of notes in Circulation as of 31 March 2023; (iii) this denomination is not commonly used for transactions, and (iv) 
the stock of banknotes in other denominations continues to be adequate to meet the currency requirement of the public.
3   RBI press release dated 1 July 2024, ‘Withdrawal of ?2000 Denomination Banknotes – Status’, https://www.rbi.org.in/
Scripts/BS_PressReleaseDisplay.aspx?prid=58199