25
Aug

The Right to Privacy Judgment: Initial Reflections on Implications for Digital Financial Services

By Malavika Raghavan, IFMR Finance Foundation

The Supreme Court of India’s judgment on the fundamental right to privacy yesterday, 24 August 2017, speaks directly to the sweeping changes we are witnessing in the way that the State and private companies use citizens’ personal data. The collection and aggregation of individuals’ data to inform the entire chain of any welfare or commercial service provision is now de rigueur. In recent years, finance has become the poster child of this opportunity to use data: for first-time users of formal finance to be identified and diligenced; for products to be designed around their needs; for their digital and social information to stand-in where they have no assets to back their promises to re-pay credit. No where is this trend more alive than in India, and no where are the risks also writ as large. In the last 2 years we have seen a billion Indian mobile subscriptions, a billion Aadhaar numbers with over 67 crore bank accounts linked to Aadhaar numbers for direct DBT transfer among other services. We have also witnessed over 3.2 million individuals financial information being compromised by PoS/ ATM malware; the potential for stored biometrics to be used in unauthorised authentications, and for unauthorised entities to access citizen’s personal data for eKYC purposes.

If the direction of travel is towards a more digital world, what are our protections and how should we think about regulating data in our country? The judgements in Justice K S Puttaswamy & Anr v. Union of India & Ors have laid down some touchstones to anchor how we navigate these questions in the years ahead. This post first picks out some key messages from the judgment (especially around informational privacy which has special relevance for the use of personal data in retail finance) and then presents initial reflections on implications for financial services.

Privacy is recognised as an inalienable, natural right situated across our fundamental rights

This judgement—coming to the Court as it does, as a result of cases filed on the legality of the Aadhaar project—grounds its reasoning within the context of the world we find ourselves in today. Technology is now part of our lives in a way that could not have been imagined when the Indian republic was formed 67 years ago. However, the principles on which we have founded our republic have continued relevance precisely because they guide us towards solutions for the intractable problems of our time.[1] Taking stock of this, the Supreme Court has confirmed that privacy is a constitutionally protected right that emerges primarily from the guarantee of life and personal liberty in Article 21 of the Indian Constitution, and also arising across a whole raft of fundamental rights contained in Part III of the Indian constitution.[2]

The Court has tied back the right to privacy to the basic values that the Constitution and Indian society aspire to. These are given voice to in the preamble, among other parts of the Constitution. Across all six judgement texts delivered by the nine judges of the bench, certain values have been seen as inherent and intertwined with individual privacy.

Privacy is seen as a postulate of human dignity, and an essential part of individual liberty. Privacy enables individual autonomy. Indeed it is seen as lying across the spectrum of protections—for instance, its existence is needed to prevent the state from discriminating between citizens (and infringing the right to equality) by keeping certain aspects private. The Court has also noted that privacy has both subjective and objective elements i.e. subjectively, the expectation of individuals (where they desire) to be left alone AND objectively, those constitutional values that shape a protected zone where the individual ought to be left alone.[3]

In Puttaswamy, the Court has made several important observations about the nature and content of privacy protections which will no doubt be the subject of scholarship and interpretation for years to come. But two observations in particular merit the attention of those working to improve access to finance for the underserved. Firstly, the Court refuses any notion of a trade-off between individual freedoms and development. The Kesavananda Bharati[4] judgment’s view is re-iterated, that Parliament cannot abrogate the essential features of the individual freedoms secured to citizens in India. Our Constitution does not take the perspective that in order to build a welfare State, it is necessary to destroy some human freedoms. Indeed, to quote “Our constitutional plan is to eradicate poverty without destruction of individual freedoms.”[5]

Secondly, and crucially for those of us tracking the use of personal data in financial services, individuals’ informational privacy is now firmly within the protection of fundamental rights.

Informational privacy is part of our expectation of privacy as Indians

Informational privacy i.e. the interest in limiting or controlling the access to information about ourselves, is dealt with in the lead Puttaswamy judgement by Chandrachud, J which devotes an entire section to it.[6] The Court takes note of the way in which technology has changed our lives, the digital trails we leave behind as we transact online, and the aggregation of these data points to reveal things about us that we may not expressly disclose. It notes the use of cookies to track online behaviour, the collection of users’ browsing histories, and other tools like automated content analysis of emails which can be analysed with algorithms to profile individual users. The Court notes that the use of data mining techniques, Big Data and the possibility of database linking essentially allow for aggregation of data about every single person in a manner previously not encountered.

Given this context, the Court notes the important role of data protection laws in safeguarding the privacy and autonomy of an individual, and ensuring non-discrimination on the basis of racial or ethnic origin, political or religious beliefs, genetic or health status or sexual orientation. The Court has recognised that a good data protection law will need to delicately balance the complex issues between individuals’ privacy interests and legitimate concerns of the state.

Para 180 of the leading judgment by Chandrachud, J contains a three-fold prescription to act as important guidance when considering how privacy might be safeguarded by ensuring:

  • that there must be a law: A law is needed to justify any encroachment on privacy, to fulfil the requirement in Article 21 of our Constitution that no deprivation of liberty can be undertaken except by a procedure established by law;
  • that law must be reasonable: Such a law must fall within the zone of reasonableness as required by Article 14 as a guarantee against arbitrary state action;
  • the law must be proportional: Any encroachment on individual privacy must be proportionate to the object and needs sought to be fulfilled by such a law.

Kaul J in his remarks presents the test of proportionality and legitimacy for limiting the state’s discretion, which requires an action to be sanctioned by law, necessary for a legitimate aim, proportionate to the need for such interference and with procedural guarantees against abuse of such interference.[7]

Reiterating the principles set out by the Government of India Group of Expert of Privacy in 2012, the Court takes note of the Committee of Experts chaired by Justice B N Srikrishna that has been constituted and will suggest a new data protection regime for the country. The work of ensuring balance is achieved in law and is manifested in practice lies ahead for all of us.

On the regulation of personal data and implications for financial services

The observations of the Court in Puttaswamy have direct implications for operational aspects of retail finance and for newer digital financial services provision. The use of new and alternative forms of data about consumers to target advertising and communication, and to appraise individuals is now a reality, as is the use of algorithms to mine data for use in processes like credit scoring. Negative outcomes from such processes that affect individuals’ privacy or cause discrimination will now be seen as infringements of fundamental rights, where state entities are involved. A horizontal data protection regime (applying to state and non-state actors) based on the same understanding of privacy would extend privacy protections for users against all types of entities.[8] As we debate the contours of privacy for our new data protection regulation and in existing financial sector regulations, we have an opportunity to shine a spotlight on existing data practices around consumers’ personal and financial information in financial institutions.

For those involved in the chain of financial services provision that is increasingly becoming more “digital”, this judgment has flagged up a new understanding of core issues. In particular, it forces more granular reflection on:

  • the kinds of data that can and should be collected, keeping in mind values of privacy and dignity of the individual;
  • the kind of data mining and algorithmic techniques that can be used, keeping in mind that such techniques cannot infringe privacy and liberty, autonomy and free choice, and equality of all individuals;
  • whether individuals’ reasonable expectations of privacy can vary based on categories and context of data; and
  • how a fair, just and reasonable law can help us find a way to ensure that the use of personal data is tied to legitimate proportionate objectives and interests.

This judgement has moved the gears for privacy and data protection in the country, ushering us into an era of change where we are seeing data protection laws globally being re-purposed for rapidly evolving technological advancements. All this will require a shift in our understanding of liability, and for our practices around accountability and reporting. All of this will need to be tackled by new data protection regulation and updating appropriate financial sector regulation – and ultimately, in the way in which our day-to-day data practices evolve within government, industry and between citizens of India.

—-

[1] Justice Puttaswamy & Anr v. Union of India & Ors, ALL WP(C) No.494 of 2012, DY Chandrachud, J at page 213. (Puttaswamy).

[2] ibid, page 262.

[3] supra n 1, para 169, page 246.

[4] Kesavananda Bharati v. State of Kerala, (1973) 4 SCC 225.

[5] Ibid, para 666, pages 486-487 cited in Puttaswamy, para 108, page 105.

[6] supra n.1, para 170 – 185, pages 246 – 260.

[7] supra n.1, Kaul J at para 71, page 27.

[8] The argument of some respondents (including the UIDAI) was that the right to privacy is a common law right. This would mean it was applicable to state and non-state actors. As noted by Bobde, J in Puttaswamy, a right can be simultaneously recognised as a common law and constitutional law right. Bobde, J also noted that the content of privacy in both forms (common and constitutional) is identical, which gives rise for the potential for similar considerations to apply across state and non-state actors. See Puttaswamy, Bobde, J at para 17-18, page 15-16.

26
Apr

Comments on the RBI Draft Master Directions on Issuance and Operation of Prepaid Payment Instruments in India

By Bhusan Jatania, IFMR Finance Foundation

The Reserve Bank of India (RBI) released the Master Directions on Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India (Draft Circular) on 20 March 2017. The IFMR Finance Foundation’s Future of Finance Initiative has provided its response to the Draft Circular.

While the Draft Circular builds upon a series of PPI related circulars issued by the RBI, it proposes significant changes such as:

  • increasing a PPI issuer’s net-worth requirement to Rs. 25 crores (from the existing Rs. 1 crore),
  • allowing PPI issuers to access payment systems in the future (without providing details),
  • requiring comprehensive system audit of PPI issuers on an annual basis (and before granting licenses to new applicants), and
  • compulsory conversion of existing PPIs (which hold minimum information about the user) to full KYC PPIs (this has to be achieved within 60 days of the Draft Circular coming into force).

In our comments to RBI we have recommended that the Draft Circular:

  • provide a higher standard of customer data protection,
  • create a more level-playing field for bank-led and non-bank led PPI issuers, and
  • clarify customer liability for unauthorised / fraudulent transactions involving PPIs.

In our response we have also compared the Draft Circular to the recent draft rules for security of prepaid payment instruments released by the Ministry of Electronics & Information Technology on 8 March 2017 (to which we also provided a response, available here).

We believe that the proposed regulatory revamp of wallet providers is driven by the principle that emergence of dominance should lead to greater supervision. The RBI appears to have taken a view that the digital payments sector, characterised by significant user expansion, has emerging customer abuse, data security and systemic risk considerations. And while the industry has raised some concerns of regulatory extravagance around the Draft Circular, it should largely be seen as a step in the right direction.

Our response to RBI’s public consultation is available here.


About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.

27
Mar

Comments on the Ministry of Electronics & Information Technology’s Draft Rules for Security of Prepaid Payment Instruments

By Malavika Raghavan, IFMR Finance Foundation

On 8 March 2017, the Ministry of Electronics & Information Technology (MeitY) released a set of draft rules for security of prepaid payment instruments (Draft Rules), inviting comments by 20 March 2017.[1] The IFMR Finance Foundation’s Future of Finance Initiative has provided its response to the Draft Rules.

The Draft Rules propose new requirements for pre-paid payment instrument (PPI) issuers, requiring them to:

  • put in place information security policy and privacy policies, and undertake risk assessments to assess risks associated with the security of their payment systems, and
  • institute a range of measures on customer identification, authentication, awareness, and education, and separately, a set of security practices.

The Draft Rules seek to broaden the category of customer information that is considered “personal information” for the purposes of the Information Technology Act, 2000 (IT Act), improper disclosure of which can be penalised by a fine up to Rs. 5 lakhs or imprisonment up to 3 years (or both). It also seeks to give transaction history data held by PPI issuers a higher degree of protection as “sensitive personal data and information” under the IT Act.[2]

The Draft Rules are an important and progressive step towards highlighting customer data protection and privacy concerns of customers using PPIs. However, MeitY has taken the interesting position of making rules for a particular institution type (PPIs here), which makes it akin to a sectoral regulator. It is also interesting to note that the Draft Rules traverse areas in which Reserve Bank of India (RBI) regulation already exists. In this regard we note that on 20 March 2017, the RBI released its updated “Master Directions on Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India”, inviting comments by 31 March 2017.

In our comments to MeitY we have sought to highlight that the Draft Rules:

  • dealing with privacy and data protection, while incorporating some of the key (and internationally recognised) data protection principles can benefit from a more complete coverage of these principles,
  • while certainly taking the lead in customer data protection, should, keeping in tune with several other jurisdictions, go a step further and consider a broadening of the scope of Sensitive Personal Data and Information (SPDI) by covering any “personally identifiable financial information that any institution collects about an individual in connection with providing a financial product or service (unless that information is otherwise publicly available) – We characterise this as “Non-Public Personal Information (NPI), and make a case for treating NPI as SPDI for the purposes of the Information Technology Act, 2000
  • should attempt consistency with the existing framework of the Information Technology Act, 2000 (particularly the Reasonable Security Practices and Procedures and Sensitive Personal Data or Information Rules, 2011) so as to avoid multiplicity of legal standards.

We consider MeitY to be best placed to continue its role as the overarching standards setting body for issues relating to security and integrity of electronic transactions, and we see the actual monitoring and enforcement of such standards to be delegated to sector specific and specialised regulators (such as RBI, SEBI, IRDA, PFRDA, TRAI, Airports Authority of India, Registrar of Companies, All India Council for Technical Education, others. Therefore, in the context of PPIs, it would be wise to take note of existing regulations and monitoring systems already present within the RBI, as further described in our response document.

Our response to MeitY’s public consultation is available here.

About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.


[1] The deadline has since been extended to 5 April 2017.

[2] For an explanation of these categories, see our blog on Electronic Financial Data and Privacy in India (published December 2016).

28
Feb

Monetary Policy Transmission in India – Part 2

By Madhu Srinivas, IFMR Finance Foundation

In the second post of our two-part series on Monetary Policy Transmission, we take a closer look at the impediments to policy transmission in India and also list the recent measures taken by RBI/Government to overcome these impediments. In addition we look at what recent empirical evidence has to say on effectiveness of policy transmission in India 

Impediments to Transmission in India

  1. Sustained fiscal dominance – RBI, being the merchant banker for the Government, has the responsibility to raise money, in this case through Government bonds, as and when needed by the Government. These Government borrowings tend to crowd out non-food credit in bank finance[1] and thereby reduce policy transmission. Though it is to be noted that steps have been taken to separate RBI from its public debt management responsibilities.[2] How effective these measures are and when they will reach their logical conclusion, however, remain uncertain. In contrast, many Emerging Market Economies (EME) such as Brazil, Poland, Hungary and South Africa have a separate debt management office to management government debt. Also, even among those EMEs where the central bank is involved in public debt management, their role is quite limited and they only act as a facilitator[3].
  2. Statutory pre-emption through Statutory Liquidity Ratio (SLR) – The SLR prescription provides a captive market for government securities and helps to artificially suppress the cost of borrowing for the Government, dampening the transmission of interest rate changes across the term structure. It was also observed that till 2014, the Government was borrowing at a negative real interest rate[4]. This was because the estimated average cost of public debt was above the average CPI inflation.
  3. Small savings scheme – Besides market borrowings, the other main source of funding government deficits in India is small savings mobilised through, inter alia, post office deposits, saving certificates and the public provident fund, such channels are characterised by administered interest rates and tax concessions. The substitution from bank deposits (both time and demand deposits) to small savings erodes the effectiveness of the monetary transmission mechanism, especially through the bank lending channel.


Source: Indian Budget 2017-18 and RBI’s Statistical tables relating to Banks of India : Table No. 10

As can be seen from the above graph, the funds in the small savings scheme are substantial compared to the bank deposits in the Scheduled Commercial Banks (SCB).

  1. Subventions – The Government also influences monetary transmission through its directives to banks. Keeping some economically and socially important objectives in mind, both the Central and State Governments offer interest rate subventions to certain sectors including agriculture[5] instead of considering direct subsidies, distorting the transmission mechanism.
  2. Informal Economy – India has a large informal sector workforce[6] and significant presence of informal finance as a significant source of credit for the real economy[7]. These are outside the influence of transmission measures.
  3. Liability Profile – The policy repo rate does not directly affect the determination of base rate of banks. The pass-through mainly hinges on the policy rate influencing the interbank rate, which in turn, influences the deposit and lending rates[8]. This pass-through is greatly diminished, since wholesale borrowings (including borrowing from the RBI and interbank borrowings) constitute barely 10 per cent of the total funds raised by banks[9].


Source: RBI’s Statistical tables relating to Banks of India : Table No. 2 ; As of March 2016

As can be seen from the above graph, the non-deposit borrowings of banks (which include borrowings from RBI and other wholesale funding) though significant, are quite small when compared to deposit liabilities. Thus their power to influence the lending rates is low. Added to this is the limited ability of banks to reduce their deposit rates in response to lowering of the policy rate. It is quite hard for banks to lower their term deposit rates (term deposits form almost 60% of all funds) in response to lowering of the policy rate by RBI. This constraint in lowering of deposit rates imparts rigidity to the liability term structure and to that extent impedes policy transmission.

Recent measures taken by RBI/Government that helps to overcome impediments to transmission 

  1. The Government, through an executive order, has set up a Public Debt Management Cell (PDMC) under the Ministry of Finance. The PDMC takes over the front office and the middle office functions of public debt management from RBI, while RBI will continue to handle the back office operations. The PDMC is to become a full-fledged body and completely take over the debt management functions from RBI in about 2 years[10].
  2. Effective from 1st April 2016, RBI has mandated all banks to move to a Marginal Cost of Lending Rate (MCLR) based regime. This rate is to be calculated taking into account –
    1. Marginal cost of funds
    2. Negative carry on account of Cash Reserve Ratio CRR
    3. Operating Costs
    4. Tenor Premium

This is set to improve the monetary policy transmission on the lending side. While early signals from the market suggest that this move would indeed increase the effectiveness of policy transmission[11], it is still too early (less than 4 quarters since the measure came into effect) to comment on the impact of this change with any certainty. Most empirical studies suggest that monetary policy transmission happens with a lag, and depending on the variable to influence, of about 2-3 quarters.

  1. With the Government resetting the interest rates for Small Saving Schemes every quarter[12], there is some scope for these interest rates to be aligned with the policy rate and thereby help transmission.
  2. There is some indication from the Finance Ministry (April 2016)[13] that it may consider replacing interest rate subvention schemes with interest subsidies paid directly into borrower accounts. However action on this is still awaited.

Effectiveness of Policy Transmission

Recent empirical research in the Indian context suggests that the bank lending rates respond asymmetrically to monetary policy, i.e lending rates respond more quickly and positively to monetary tightening than to monetary loosening[14][15][16]. Also there seems to be some evidence of pass-through in the first leg of policy transmission – Policy rates to Bank Lending rates. However, with regard to the second leg of policy transmission – Bank Lending/Financial Market rates to economic output/demand, the evidence seems to suggest little or no pass-through[17]. One reason for this could be the low level of penetration of formal financial intermediation in our economy. Put differently what it means is that the interest rate decided by RBI seems to significantly influence the bank lending rates in the right direction, especially when RBI raises the rate. But this does not seem to impact the output or price of goods and services in any substantial way. One reason for this is that large sections of our population still do not save in or borrow from banks or other formal financial institutions. However, with the current thrust on financial inclusion and the consequent spread of the formal financial system, the transmission in this leg is likely to get strengthened over time.

[1] Urjit Patel Committee Report (2014), Chart IV.2

[2] The Hindu Businessline – Debt management office to gradually-end; Oct 2016

[3] Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chair: Dr. Urijit Patel, 2014)

[4] Ibid, Chart IV.3

[5] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=10540&Mode=0

[6] http://www.ilo.org/wcmsp5/groups/public/—asia/—ro-bangkok/—sro-new_delhi/documents/publication/wcms_496510.pdf

[7] http://www.mospi.gov.in/sites/default/files/publication_reports/KI_70_18.2_19dec14.pdf

[8]Sonali Das , IMF working paper WP/15/129 – Monetary Policy in India : Transmission to Bank Interest Rates

[9] Urjit Patel Committee Report (2014)

[10] The Hindu Businessline – Debt management office to gradually-end ; Oct 2016

[11] Indian Express – Private Sector capex ; Oct 2016

[12] Press Information Bureau release ; March 2016

[13] The Hindu Businessline – Govt. to pay interest subsidy directly to borrowers ; April 2016

[14] Mishra, Montiel and Sengupta (2016) , “Monetary Transmission in Developing Countries – Evidence from India”

[15]Bhupal Singh (RBI 2011) , “ How asymmetric is the monetary policy transmission to Financial markets in India”

[16]Sonali Das , IMF working paper WP/15/129 – Monetary Policy in India : Transmission to Bank Interest Rates

[17]Mishra, Montiel and Sengupta (2016), “Monetary Transmission in Developing Countries – Evidence from India”

21
Feb

Monetary Policy Transmission in India – Part 1

By Madhu Srinivas, IFMR Finance Foundation

Monetary policy plays a significant role in determining the trajectory of a country’s economy. While not directly affecting the structure of a financial system, the policy significantly influences the actions of economic agents of the financial system, including financial institutions. In that respect, the mechanics and effectiveness of transmission is of considerable interest to us. In this post, which is the first in a two-part series, we take a brief look at the mechanics of Monetary Policy Transmission in general and how it operates in India.

Introduction

Dr. Raghuram.G. Rajan, former RBI Governor, in a statement after assuming office on September 4, 2013 observed that:

The primary role of the central bank, as the RBI Act suggests, is monetary stability, that is, to sustain confidence in the value of the country’s money. Ultimately, this means low and stable expectations of inflation, whether that inflation stems from domestic sources or from changes in the value of the currency, from supply constraints or demand pressures.” While there are many views on the objectives of monetary policy, the above statement captures the broad commonalities among the various views and could be taken as the official stance of RBI. This is further strengthened with the RBI formally adopting Inflation Targeting Framework.

It is generally accepted in literature that monetary policy has limited effects on aggregate supply or productive capacity. However, in the presence of credit constraints, the ability of firms to expand capacities is impacted, thus affecting aggregate supply[1]. Following the financial crisis of 2008-09 overall monetary policy transmission seems to have weakened in most Advanced Economies (AE)[2]. In contrast, recent evidence suggests that the interest rate channel, one of the many channels for monetary policy transmission, is strengthening in many Emerging Market Economies (EMEs), including India[3]. This can be attributed, among other things, to reduced fiscal dominance, more flexible exchange rates and development of market segments[4].

Prior to the recommendations of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chair: Dr.Urjit Patel, 2014), India was following reserve targeting as the mechanism for monetary policy transmission – i.e., base money, borrowed reserves, and non-borrowed reserves. However, we have moved towards a formal, interest rate targeting regime (based on CPI) and away from the earlier reserve money system. One of the main reasons for moving from a money aggregate system to an interest rate regime is the erosion in stability and predictability of the relationship between money aggregates, output and prices. This erosion was further exacerbated with the proliferation of financial innovations, advances in technology and progressive global integration.

Mechanics of Transmission

The transmission mechanism can be characterised by the Taylor’s rule of thumb[5] (a simplified version of one of the main quantitative tools used by central bankers to arrive at a nominal policy interest rate) –

i =π + r* + 0.5(π –π*) + 0.5 (y – y*)], or [ i =π* + r* + 1.5(π –π*) + 0.5 (y – y*)]

Where

i = nominal interest rate

π = rate of inflation

π* = inflation target

r*= neutral real rate

(y-y*) = output gap

The policy transmission mechanism broadly involves two steps –

  1. Transmission from the policy rate to key rates in the financial markets
  2. Transmission from the financial markets to final objectives like inflation, employment and output

The effectiveness of transmission in both steps depends to a large extent on the structure of the financial system. The three main components of the system which determine effectiveness are[6] –

  1. The size and reach of the system – given that the formal financial system does not intermediate for most economic agents in India, this weakens transmission
  2. The magnitude of financial frictions – a recent empirical study[7] suggests that the relative scarcity, or impediments, in the provision of public goods in India, such as – enforcement of property rights, efficiency and impartiality of the legal system, adequacy of accounting and disclosure standards –  tend to enhance the frictions in the financial sector and, to that extent, impede policy transmission
  3. The degree of competition in the financial sector – there is evidence[8] that the banking sector is highly concentrated in India, suggesting a low degree of competition in the sector

In sum, it can be said that the structure of the financial sector in India tends to weaken the monetary policy transmission.

Channels of Transmission

Monetary policy transmission in India happens through the following channels –

  1. Interest Rate channel – Empirical studies show that there exists bi-directional causality between call money rates and interest rates in other segments such as the government debt market, credit market or equities market and the forex market[9]. Also studies have shown that the transmission through this channel is asymmetric, i.e the extent of policy rate transmission is different between liquidity surplus and liquidity deficit conditions, with the transmission being more effective during liquidity deficit conditions[10]. One reason could be that banks would be more dependent on liquidity provided by RBI during tight liquidity conditions and hence more sensitive to the short term interest rate influenced by RBI.
  2. Credit channel – India is banking-dominated economy, even though the role of equity and debt markets has been rising the past few years[11]. High-dependence on bank finance makes the bank lending and the balance sheet channels particularly important for monetary transmission, which is also seen through Granger causality tests[12]. In terms of balance sheet effects, credit growth is seen to have an inverse relationship with movements in the policy rate. A 100 basis points increase in policy rate reduced the annualised growth in nominal and real bank credit by 2.78 per cent and 2.17 per cent, respectively[13].
  3. Exchange Rate channel – The exchange rate channel works primarily through consumption switching between domestic and foreign goods. This channel is weak in India with some evidence of weak exogeneity[14]. This is mainly because of India’s limited integration with world financial markets and RBI’s intervention in forex markets[15]. Despite all this, it is found that exchange rate depreciation is a key source of risk to inflation[16].
  4. Asset Price channel – Empirical evidence for India indicates that asset prices, especially stock prices, react to interest rate changes, but the magnitude of the impact is small[17]. With the increasing use of formal finance for acquisition of real estate, the asset price channel of transmission has improved. However, during periods of high inflation, there is a tendency for households to shift away from financial savings to other forms of savings such as gold and real estate that tend to provide a better hedge against inflation. To the extent that these acquisitions are funded from informal sources, they may respond less to contractionary monetary policy, thus weakening the asset price channel in India[18].

In all this, it should be borne in mind that there is considerable lag in the transmission of monetary policy. In India, monetary policy impacts output with a lag of 2-3 quarters and WPI inflation with lag of 3-4 quarters, with the impact persisting for 8-12 quarters. Also as can be seen from the above summary of channels, the interest rate channel is the strongest[19].

In the next post, we will take a closer look at the impediments to policy transmission in India and also list the recent measures taken by RBI/Government to overcome these impediments. Finally we will look at what recent empirical evidence has to say on effectiveness of policy transmission in India.


[1] Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chair: Dr. Urijit Patel, 2014)

[2] Bouis (2013) et al, OECD Working Paper No. 1081

[3] Mohanty, M.S. and P. Turner (2008): “Monetary Policy Transmission in Emerging Market Economies: What is New?”, BIS Policy Paper No.3, January

[4] Gumata, N., A Kabundi and E. Ndou (2013): “Important channels of transmission of monetary policy shock in South Africa”, ERSA Working Paper No. 375, Cape Town

[5] Urjit Patel Committee Report (2014)

[6] Mishra, Montiel and Sengupta (2016) :“Monetary Transmission in Developing Countries – Evidence from India”

[7] Ibid

[8] Ibid

[9] Urjit Patel Committee Report (2014)

[10] Bhupal Singh (RBI 2011) :“ How asymmetric is the monetary policy transmission to Financial markets in India”

[11] Ibid , Chart IV.1

[12] ibid

[13] Pandit, B.L. and P. Vashisht (2011), “Monetary Policy and Credit Demand in India and Some EMEs”, Indian Council for Research on International Economic Relations, Working Paper No.256, Khundrakpam (2011) and Khundrakpam and Jain (2012)

[14] Ray, P., H. Joshi and M. Saggar (1998): “New Monetary Transmission Channels: Role of Interest Rate and Exchange Rate in the Conduct of Monetary Policy”, Economic and Political Weekly, 33(44), 2787-94

[15] Mishra, Montiel and Sengupta (2016): “Monetary Transmission in Developing Countries – Evidence from India”

[16] Urjit Patel Committee Report (2014), Table IV.1

[17] Singh, B. and S. Pattanaik (2012): “Monetary Policy and Asset Price Interactions in India: Should Financial Stability Concerns from Asset Prices be Addressed Through Monetary Policy?”, Journal of Economic Integration, Vol. 27,167-194

[18] Urjit Patel Committee Report (2014)

[19] ibid