Indian Parliamentary Research Service Legislative Summaries

Bill Summary

The Reserve Bank of India (Amendment) Bill, 2005

· The RBI (Amendment) Bill, 2005 was introduced in the Lok Sabha on May 13, 2005. The Standing Committee on Finance submitted its report to Parliament on December 1, 2005.

· The Bill has three distinct objectives: (a) Increasing the flexibility on the Cash Reserve Ratio (CRR), (b) Allowing RBI to transact in a wider set of instruments, and (c) Regulating transactions in derivatives, money market instruments or securities etc.

· CRR. The Bill seeks to give greater flexibility to RBI to determine CRR. This ratio determines the proportion of a bank’s liabilities that it must keep in cash or as a deposit with RBI. The RBI Act, 1934 (Principal Act) allows the RBI to fix CRR between 3% and 20% of a bank’s net demand and time liabilities. It also specifies that RBI will not pay any interest for the first 3%, and will notify the interest rate (currently the Bank Rate) on CRR beyond 3%. The amendment removes the cap and floor on the range for CRR; it also specifies that CRR will not carry any interest.

· Transactions. The Bill seeks to permit RBI to

- Deal in derivatives where the underlying is (a) interest rates, (b) prices of central and state government securities, and such securities of local authorities as specified by central government, (c) price of foreign securities, (d) index of rates or prices, (e) foreign exchange rate, (f) credit rating or credit index, (g) price of gold or silver coins or bullion, (h) any other variable of similar nature.

- Deal in any other financial instrument with the approval of the central government

- Lend or borrow central and state government securities, and such securities of local authorities as specified by central government

- Deal in repo or reverse repo where the underlying is central or state government securities, or such securities of local authorities as specified by central government, or foreign securities.

· Regulating derivatives, money market instruments etc.

- The Bill defines derivatives as those in which the underlying is any interest rate, foreign exchange rate, credit rating or credit index, price of securities (only those issued by central and state governments or specified securities issued by local authorities), or a combination of these. These include interest rate swaps, forward rate agreements, foreign currency swaps, foreign currency options, foreign currency rupee options or any other instrument that may be specified by RBI.

- All transactions in derivatives will be considered valid if one of the parties is RBI, any scheduled bank or any agency falling under the purview of RBI. This validity applies with retrospective effect.

· RBI may determine the policy relating to interest rate and interest rate products, and this will be applicable to all agencies dealing in such products. RBI may not issue directions relating to execution or settlement of trades on stock exchanges.

M R Madhavan

madhavan@prsindia.org

March 17, 2006

Parliamentary Research Service n Centre for Policy Research n Dharma Marg n Chanakyapuri n New Delhi – 110021

Tel: (011) 2611 5273-76, Fax: 2687 2746