CPT Section C General Economics Chapter 8 Unit 3 The Reserve Bank of India.

CA Shweta Poojari

Introduction

Functions of RBI

Role of RBI

Indian monetary policy

Instruments of Credit controls

Multiple Choice Questions

The Reserve Bank of India is the central bank of the country and it performs all the central banking functions.

Reserve Bank of India was setup on 1st April 1935 as the shareholders bank.

RBI was nationalized on 1st January 1949.

The Executive head of the Bank is called the Governor, who is assisted by Deputy Governors and other executive officers.

The General superintendence and direction has been entrusted to the Central Board of Directors, consisting of the Governor, Dty. Governors, one Govt. Official from the Ministry of Finance and Directors nominated by the Govt. of India representing the Local Boards and various elements of the economy.

Besides the Central board there are 4 Local Boards with headquarters in Mumbai, Kolkata, Chennai and New Delhi.

Supervision and control over Commercial Banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction and liquidation.

Issue of Currency

Banker to the Government

Banker’s Bank

Custodian of foreign exchange reserves

Controller of credit

Lender of last resort

Central clearance, settlement and transfer of money

Promotional functions

Collection and publication of data

Others

The RBI is the sole authority for the issue of currency in India other than one rupee notes and subsidiary coins, the magnitude of which is relatively small. The RBI is also called ‘Bank of issue’

The One Rupee notes and coins are issued by the Central Govt. , The Ministry of Finance.

As a Banker to the Govt. RBI performs the foll. Functions.

a. It accepts money , makes payment and also carries out their exchange and remittances for the Govt.

b. It manages public debts, advices the government on the quantum, timing and terms of new loans.

c. It also sells treasury bills to maintain liquidity in the economy.

d. Fiscal agent and advisor to the Govt.

The RBI has extensive power to control and supervise commercial banking system under the RBI Act, 1934 and the Banking Regulation Act, 1949.

The banks are required to maintain a minimum of cash reserve ratio (CRR) with RBI. The RBI provides financial assistance to scheduled banks and state co operative banks.

The RBI is the custodian of monetary reserve in India and RBI also is the custodian of national reserve of international currency.

• It has to ensure that normal short term fluctuations do not affect the exchange rate.

Credit control is generally considered to be the principal function of central bank. By making frequent changes in monetary policy, it ensures that the monetary system in the economy functions according to the nation’s needs and goals.

The RBI uses almost all Quantitative and Qualitative methods of credit controls.

RBI is the official ‘Lender of the last resort’.

Lender of last resort means central bank coming to the rescue of other banks in times of financial crises.

Central bank has special position for conducting clearinghouse operations, Inter-bank transfer of funds and settlement of accounts.

i.e. settling the mutual Owings of banks

RBI also performs variety of Developmental and Promotional functions.

It is responsible for promoting banking habits among people, mobilizing savings, development of the banking system, and provision of finance for agriculture, Foreign trade and small scale industries

It has also been entrusted with the task of collection and compilation of statistical information relating to banking and financial sector of the economy.

The other Misc. Functions of RBI are:

The RBI is responsible for overall monetary policy in India like monetary stability, Stability of domestic price levels, Maintenance of the International value of the nation’s currency etc.

1.The RBI is apex monetary institution of the highest authority in India. It plays an important role in strengthening, developing and diversifying the country’s economic and financial structure.

2. It is responsible for the maintenance of economic stability and assisting the growth of the economy.

3. It is India’s prominent public financial institution given the responsibility for controlling the country’s monetary policy.

4. It acts as an advisor to the government in its economic and financial policies.

5. It is responsible for the development of an adequate and sound- banking system in the country.

6. RBI has to keep inflationary trends under control and to see that the main priority sectors like agriculture , exports and small scale industry get credit at cheap rates.

7. It also has to protect the market for government securities and channelize credit in desired direction.

COMMERCIAL BANK CENTRAL BANK It is profit-seeking institution Its objective is not to make profit Its profits mainly from loans and advances

Its profits are mainly from Government securities, advances to government and commercial banks

Banks Mobilize savings and channelize them into investments.

Central Bank’s role is to ensure that the other banks Properly conduct their business in national interest.

Functions of commercial banks are different

Functions of central banks are unique

Meaning: • Monetary policy is the one employed by the state through its

central bank, to control the supply of money as an instrument of achieving the objectives of general economic policy.

Objectives: • a. To regulate monetary growth and maintain price stability • b. To ensure adequate expansion in credit • c. To assist economic growth • d. To encourage the flow of credit into priority and neglected

sectors • e. To strengthen the banking system

Quantitative or General Measures Qualitative or selective Measures

Bank Rate Policy Margin Requirements

Open market operations Consumer credit regulation

Variable reserve requirements Issue of directive

(i) cash reserve ratio (ii) Statutory liquidity ratio

Rationing of credit

Moral suasion

Direct action

General measures of credit control

The bank rate is the official interest rate at which the central bank rediscounts the approved bills held by a commercial bank. If the central bank wishes to control credit and inflation, it will increase the bank rate

At present the Bank Rate is 9%.

•

OMO imply deliberate and direct sales and purchases of securities and bills in the open market by central bank to control the volume of the credit. If it wishes to control credit inflation, then central bank sells securities in the open market.

If central bank wishes expansion of credit at the time of deflation, then it purchases the securities.

The central bank also uses method of variable reserve requirement to control credit. There are two types of reserves, which the commercial banks are generally required to maintain.

Cash reserve ratio [ C.R.R]

• refers to that portion of total deposits, which a commercial bank has to keep with RBI in the form of cash reserves.

Statutory liquidity ratio [ S.L.R]

• refers to that portion of total deposits, which a commercial bank has to keep with itself in the form of liquid assets.

During Inflation, to Control Inflation and Discourage investment, it is advisable to;

Increase the Bank Rate Sale of Securities in the open market Increase the CRR and SLR

During Deflation, to Control Deflation and Encourage investment, it is advisable to;

Decrease the Bank Rate Buying of Securities in the open market Decrease the CRR and SLR

Qualitative or Selective Measures

1.Margin Requirements:

A margin requirement is difference between securities offered and amount lent against those securities by the banks. Increase in margin reduces the borrowing capacity and decrease in margin increase the borrowing capacity.

2. Consumer credit regulation

Laying down rules regarding down payments and maximum maturities of installment credit for the purchase of specified consumer durable goods. Raising the required down payment limits and shortening of maximum period tend to reduce the demand for such loan and thereby check consumer credit.

3. Issue of directive:

The central bank also uses directives in form of oral, written statement, appeals or warnings to various commercial bank for credit control.

4.Rationing of credit:

Rationing of credit is a selective method adopted by central bank for controlling and regulating the purpose for which credit is granted by commercial banks.

5. Moral suasion:

Moral suasion is a psychological means and purely informal and milder form of selective credit control. In moral suasion central bank persuades and morally requires to the commercial banks to co-operative with the general monetary policy of credit control.

6. Direct action:

The central bank may take direct action against the erring commercial banks or it may charge a penal rate of interest over and above the bank rate, for the credit demanded beyond the prescribed limit.

MCQ’s

a.Providing cheap rediscounting facilities to commercial banks

b.Providing liberalised rediscounting facilities to commercial banks

c.Giving subsidies to new banks

d.All of the above

Answer:d

a. RBI Act, 1934

b. Banking Regulation Act, 1949

c. Both RBI Act 1934 and Banking Regulation Act 1949

d. Banking Regulation Act, 1960

Answer:C

a. It can bring about compulsory amalgamation of weak banks

b. It can claim for compulsory liquidation

c. It can expedite winding up of proceedings to safeguard the interest of depositors

d. All of the above

Answer:d

a. Uniformity in note issue

b. Stability in currency

c. Control of credit

d. All of the above

Answer.: D

a. Create

b. Controls

c. Restricts

d. None of the above

Answer.: B Explanation.: Creation of credit is done by commercial banks.

a. Dear

b. Cheap

c. Restricted

d. Green

Answer.: B Explanation.: People will borrow more and spend/Invest more.

a. Bank rate policy

b. Cash reserve ratio

c. Statutory liquidity ratio

d. All of the above

Answer:d

a. Control inflation

b. Discourage hoarding of commodities

c. Encourage flow of credit into neglected sector

d. All of the above

Ans.: D Expln: (Please refer Slide No.:21)

a. Credit

b. Financial

c. Monetary

d. fiscal

Answer;C

a. RBI advances necessary credit against eligible securities.

b. Commercial banks give fund to RBI

c. RBI advances money to public whenever there is any emergency.

d. All the above.

Answer:A

a. Rate at which commercial banks lend money

b. Rate at which RBI lends to commercial Banks.

c. Rate of interest paid by the banks to its depositers.

d. None of the Above.

Answer: B Bank rate is the rate at which the Central Bank

gives loans or rediscounts the bills of

exchange to the commercial banks.

a. 9%

b. 10%

c. 4.5%

d. 23%

Answer: A Note : the bank rate is as updated up to

Sept. 2012.

a. 4.5%

b. 7.5%

c. 15%

d. 23%

Answer:A Note : the CRR is as updated up to Sept.

2012.

a. 4.5%

b. 7.5%

c. 15%

d. 23%

Answer:D Note : the SLR is as updated up to Sept.

2012.

a. RBI is a Profit making institution acting in the interest of the Govt.

b. Every country has only one central bank which is managed by Govt. officials.

c. RBI does not perform any ordinary commercial banking functions.

d. RBI has adopted Minimum Reserve System of Note Issue.

Answer:A RBI is not a profit

making Institution and it acts in the public

Interest.