Commercial Banking System & Role of RBI

NMIMS Assignment December 2023

1) Independence of Central Bank is very crucial for impartial functioning and fair play in the economy. Any closeness of Central Bank to Ministry of Finance will not be fair and it will be viewed as baby of the government and will be looked with suspicion. Do you agree or disagree with the above statement and what is your stand?

The question of central bank independence is a topic of debate in economics and policymaking. Here are some points on both sides of the argument:


  1. Impartiality: An independent central bank can make monetary policy decisions without political pressure, which is essential for maintaining economic stability. It can focus on long-term economic goals rather than short-term political objectives.
  2. Credibility: Central bank independence can enhance the credibility of monetary policy. When people believe that the central bank is free from political interference, they are more likely to have confidence in its actions, which can help anchor inflation expectations.
  3. Avoiding Populism: Independence can help prevent the central bank from pursuing policies that might be popular in the short term but harmful in the long term. Politicians may be tempted to use monetary policy to boost their popularity before elections, leading to inflationary pressures.


  1. Accountability: Some argue that too much independence can lead to a lack of accountability. If central banks make significant decisions without oversight, it can be difficult for the public to hold them accountable for their actions.
  2. Democratic Concerns: Central banks are unelected bodies, and giving them too much independence may raise democratic concerns. Critics argue that important economic decisions should be made by elected officials who are accountable to the people.
  3. Effectiveness: In some cases, close coordination between the central bank and the finance ministry can be beneficial, especially during financial crises. Working together can help address economic challenges more effectively.

Ultimately, the degree of central bank independence is a matter of balancing these factors within the specific context of a country’s economic and political system. Different countries have different models of central bank independence, and the optimal level of independence may vary depending on the circumstances and objectives of policymakers. It’s essential to consider the pros and cons carefully when evaluating the role and independence of a central bank in any given economy.

2) RBI has different parameters for evaluating the performance of bank. These criteria emanates from different roles played by commercial banks. Explain the different parameters on which banks are rated on scale of 1 to 5. Here 5 is rated as unsatisfactory/poorly performing bank, while 1 rating is deemed as a well run bank.

The Reserve Bank of India (RBI) uses various parameters and criteria to evaluate the performance of commercial banks. These parameters are crucial for assessing the financial health, stability, and overall effectiveness of banks in fulfilling their roles in the Indian economy. Here are some of the key parameters on which banks are typically rated on a scale of 1 to 5, with 5 being rated as unsatisfactory or poorly performing and 1 as a well-run bank:

  1. Asset Quality (NPA Ratio):
    • Rating 1: Low Non-Performing Assets (NPAs), indicating a healthy loan portfolio.
    • Rating 5: High NPAs, suggesting a significant proportion of bad loans.
  2. Capital Adequacy Ratio (CAR):
    • Rating 1: High capital adequacy, indicating a strong financial base.
    • Rating 5: Low capital adequacy, implying potential financial instability.
  3. Liquidity Position:
    • Rating 1: Strong liquidity, ensuring the bank can meet its short-term obligations.
    • Rating 5: Weak liquidity, which can lead to difficulties in meeting short-term obligations.
  4. Profitability:
    • Rating 1: Consistently profitable operations, with a healthy return on assets and equity.
    • Rating 5: Sustained losses or low profitability, indicating financial distress.
  5. Operational Efficiency:
    • Rating 1: Efficient cost management, low operational expenses, and high productivity.
    • Rating 5: High operational costs and inefficiencies.
  6. Asset-Liability Management (ALM):
    • Rating 1: Effective management of asset and liability maturities, reducing interest rate risk.
    • Rating 5: Poor ALM, leading to interest rate risk and potential losses.
  7. Governance and Risk Management:
    • Rating 1: Strong corporate governance, effective risk management practices.
    • Rating 5: Weak governance and risk management, exposing the bank to potential risks.
  8. Compliance and Regulatory Adherence:
    • Rating 1: Strong compliance with regulatory requirements and guidelines.
    • Rating 5: Non-compliance with regulations, posing legal and reputational risks.
  9. Customer Service and Satisfaction:
    • Rating 1: High customer satisfaction and effective customer service.
    • Rating 5: Poor customer service and dissatisfaction among customers.
  10. Innovation and Technology Adoption:
    • Rating 1: Adoption of modern technology, innovation in services.
    • Rating 5: Lagging behind in technology adoption, resulting in inefficiencies.

It’s important to note that these ratings are not static and can change over time based on a bank’s performance. RBI uses these criteria to monitor and regulate banks, ensure the stability of the financial system, and protect the interests of depositors and the broader economy. Banks that consistently receive low ratings may face regulatory actions or interventions to address their issues and improve their performance.

The above solution is provided for reference purposes only.

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